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Correction methods for failing to make SEP contributions for employees


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A sole proprietor (sp)set up a SEP plan for himself in 1998, fully believing he had selected 3 years eligibility. The accountant confirmed this. At that time, he had no employees. Instead, the bank writes in one year eligibility on the form. He contributes for himself for 1998 and 1999. For 2000, he tells his accountant that several of his employees are now eligible to receive a contribution. The accountant routinely checks the document, and discovers the error. What are the methods to correct for 1999. The bank wants sp to treat the 1999 contribution for himself as an excess, take a refund and file a 5330, which seems draconian. The owner is angry and refuses to fund the missing contributions. Anyone have any other ideas?

NOTE: This thread continues on page 2

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Under Rev. Proc. 2001-17 the appropriate correction method is to fund the undercontribution and make up earnings thereon.

This maybe nothing, but your facts confuse me. If there are no employees in '98 and the plan requires at least one year wouldn't that mean the employees enter in 2000.

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I agree with R. Butler, I am a bit confused as to when the employees started working for the employer. We also need to know when the employer started the business, becuase the SEP eligibility reqirements looks at the last five preceeding years , i.e. preceeding the year for which the contribution is being made.

Notwithstanding the above, the option to make additional contributions for those employees has passed for 1999, as this would had to have been done by the employers tax filing deadline for 1999. At this point, contributions made to the employer are excess contributions and should be removed from the IRA

Note also that form 5330 is for qualified plans, not SEP IRAs

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Guest Fishchick

If a corrective contribution is necessary, the employer's tax-filing deadline is irrelevant. The contributions must be made prior to the deadline in order for the employer to receive a deduction. However, in a corrective situation, the employer can make a contribution. I believe the employer also files 5330, and pays a 10% funding deficiency penalty.

Question? Is the employer using the IRS Model document? If so, maybe he could hold a seance and come up with an old document that is completed correctly......

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First, let me say that I am enjoying this discussion. Lately, not many interesting questions are being submitted.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

With regard to an a SEP Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, is used to report the 10 percent excise tax on the following:

• Nondeductible employer contributions to SEPs, [iRC 4972(d)(1)(A)(ii)]

• Prohibited transactions [iRC 4975(a), 4975(e)(1)]

• Excess contributions to plans with cash or deferred arrangements [iRC 4979(a), 4979(e)(4)]

etc etc

refer

http://www.irs.ustreas.gov/cgi/websys_fmanage - the form and

http://ftp.fedworld.gov/pub/irs-pdf/i5330.pdf - the instructions

It seems to me than that none of these apply to this situation, therefore, the form is not necessary.

The problem is the employer did not follow the written contribution formula according to the plan he/she adopted, therefore, what we have here is a SEP allocation excess (Prop. Treas. Reg. Sec. 1.408-7(f))

If the allocation formula, according to the SEP document is not followed, the SEP could be disqualified, especially if it is determined that contributions were made in favor of highly compensated employees.

One way of correcting such excess is to make contributions for those employees who received insufficient contributions, however, as I stated before ,this correction must be made before the employers tax return due date plus extensions.

The other option is to revise the compensation of the employee/s who received the excess contribution Prop. Treas. Reg. 1.408-7(f). See This reg provided a formula for making this correction.

Since the lowest common denominator is "0%;" all contributions are excesses under the regulations. (Moderator)

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Guest Fishchick

Appelby, check out lines 30 and 31 of 5330.

Find this info in IRS Revenue Procedure 2001-17

"(4) Treatment of undercontributions to a SEP.

(a) Make-up contributions; earnings. The Plan Sponsor should correct undercontributions to a SEP by contributing make-up amounts that are fully vested, adjusted for earnings credited from the date of the failure to the date of correction.

(B) Earnings adjustment methods.

(i) The earnings rate generally is based on the investment results that would have applied to the corrective contribution if the failure had not occurred.

(ii) Insofar as SEP assets are held in IRAs, there is no earnings rate under the SEP as a whole. If the Plan Sponsor is unable to determine what the actual investment results would have been, a reasonable interest rate may be used"

Thought this would be helpful.

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I see your point Fishchick

However, Lines 30 and 31 applies to plans that are subjected to the minimum funding requirement, i.e. money purchase pension, defined benefit pension and target benefit etc.

Ergo, it does not apply to a SEP IRA, as SEPS generally, do not have a minimun funding requirement.

I think we are in agreement on the correction procedures.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Appleby,

I am confused by your corrective suggestion. You seem to be saying that a corrective contribution can only be made if deposited by the due date of employer's federal tax return for that year, including all valid extensions.

My difficulty in your reasoning is this, if the contribution was made by the due date of the employer's federal tax return then there is no problem. The contribution is not required to be made until that date. Therefore why would the correction method be discussed in Rev Proc 2001-17 if it can't be made.

I may be missing something, I just can't figure out what.

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  • 3 months later...

(1) SCP is not available to correct egregious failures. For example, if an employer has consistently covered only highly compensated employees under a plan, or if contributions for the HCs were made over the §415 limit, these failures would be considered to be egregious. Egregious failures may be corrected under VCP.

SEPs are eligible to submit corrections under the following programs only - VCP (the special VCSEP procedure), SCP and Audit CAP.

(2) Here, the owner would have participated had a 3 year reqiuirement been adopted when the plan was originally established. The plan could have been amended (before 2000 - had the error been discovered at that time) to provide a 3 year requirement. Bad advice, bad results!

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  • 1 month later...

A few thoughts--> Would the owner have been eligible with a one OR three year requirement AT THE TIME THE PLAN WAS ORIGINALLY ESTABLISHED. A one-year requirment would have required service to have begun in 1997; 1995 with a three-year requirment. I do not believe that correcting contributions can be made (see above regarding egregious errors) in this case and that the amounts contributed are all excesses. Also, the 10% tax is cummulative, that is, until the amount is included on W-2 or (taken into income if self-employed). Thus, the 1998 excess is subject to three 10% penalties (1998, 1999, and 2000; 4 penalties if not taken into income in 2001).

It is unlikely the bank changed a "1" to a "3" or a "3" to a "1." It is more likely that the form was blank; thus the requirement "that all blanks be completed" was not met and the plan was actually never adopted. If the bank added anything after it was signed, the "amendment" doesn't count!

If the bank did complete the agreement and it was LATER signed without having been read, then it would appear that the client has a big problem.

If the SEP-IRA has all assets withdrawn and there is a loss (a la Bin Laden) the loss may be deductible under Code Section 212 (subject to the 2% AGI limit) as a miscellaneous itemized deduction.

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