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What does the document say?

Not if they enter under the LTPTE regs.

Recognizing RatherBeGolfing’s observation that the truth might not be one-sided: If you help uncover the past, get the plan sponsor/administrator’s attorney to engage you to assist her. That way, what you communicate to the attorney can be shielded under evidence-law privileges for lawyer-client communications and attorney work product.

There is no requirement that the hypothetical account balance be limited to the 415 max lump sum. 415 controls what can actually be paid out of the plan, so if the hypothetical account balance exceeds the maximum lump sum on the actual distribution date, then the entire hypothetical account balance could not be paid. But purely from a plan design perspective it doesn't matter.

So the participant was working up until they died? As long as the plan document offers a lump sum option for the death benefit, then the beneficiary can take the lump sum, and use the account balance RMD method to calculate the amount that is not eligible for rollover.

That makes it somewhat easier. You can suggest to proceed with the plan termination with a proper communication advising the sponsor of the potential disqualification risk upon audit. Make sure you create a well organised paper trail having your advices well documented. The burden is on the plan sponsor. Billing hourly (vs a previously agreed fixed) might be a good idea as well. And here is a reminder (I have almost tripped over that several times myself so I am paranoid now) - although no F-5500-EZ is not required, the SB still has to be prepared. Do not forget to review if the combined assets are over 250K if there is a 401(k) plan.

We have, too... our client has an ESOP and a 401(k)... the erroneous SSA penalty was $20k for one plan and $13k for the other. On a $77k refund, the IRS was only going to refund the difference of $44k... pretty significant chunk. To boot, the client responded to the initial error for both plans back in August and the IRS had STILL not fixed it when the client got their refund notice in November. I recommended my client call the IRS and sit on hold for however long is necessary to set them straight, since sending written communication did no good whatsoever. Such a waste of time.

Just to clarify to ensure I have been doing it right, I instruct my clients to get an EIN for their plan (I facilitate this). When an investment account is opened I have instructed the financial advisor to register the account to the plan and use the EIN assigned to the plan. I tell them to NOT use the business' EIN on the investment accounts. Further, when a distribution occurs the plan's EIN is used on the 1099-R, not the business' EIN Pretty logical. All good?

no way out, NHCE gets 3% and HCE would get whatever % the testing would support. To avoid the TH, you could had excluded HNCE from the Plan alltogether but then you would have a coverage issue. Bottom line, the HNCE must get 3% if the PLan is TH. But is it?

Paul I, thanks for that excellent and detailed analysis. I believe that in a "pooled" situation, or as you say a loan being a general asset of the plan, it is best (required?) that the loan effectively becomes an earmarked asset (i.e. self-directed) when it is deemed. Then, at the later time of offset, the interest just washes away along with the loan. If it is maintained as a general asset of the plan, the written-off interest would be a loss to all of the participants (it was phantom interest at the time it was accrued so it all nets out on a global basis, but different participants who come and go will be affected differently). If the participant does make payments...ugh. I think there is something wrong with all of us who seem to enjoy this discussion!

Let's be mindful that a loan to a participant is an asset of the plan. The loan may be a general asset or may be earmarked as an asset to the participant. Since most loans are from individual account plans and are earmarked as an asset of the participant, most discussions of loans assume that loan rules are solely between the individual and the plan. Let's recast the conversion from the perspective of a loan as a plan asset: A participant takes out a loan from the plan. The participant gets cash and the plan gets a promissory note. The participant makes repayments that include principal and interest. The principal repayment reduces the outstanding principal on the promissory note and the interest is income to the plan. All is in balance. The participant stops making repayments on the loan. The principal on the promissory note no longer is being repaid, and the plan no longer is receiving interest as income to the plan. The loan goes into default and the outstanding amount of the promissory note is declared a deemed distribution and reported as taxable to the participant (after all, the participant effectively still has the "cash" from the remaining original principal of the loan): The plan still hold the promissory note for the remaining outstanding principal. According to the terms of the promissory note, this outstanding principal continues to accrue interest effectively increasing the amount due to the plan from the participant. If the plan loan is earmarked to the participant, the plan remains an asset in the participant's account. If the plan loan is not earmarked to the participant, the participant's accrued benefit is not affected. If the loan is offset (say the participant terminates employment): The promissory note is worthless as a plan asset that the associated accrued interest and the remaining loan principal are written off by the plan as an investment loss. After the deemed distribution, the participant never repaid any additional principal or interest, and the participant does not receive any additional distribution on the amount of the loan offset. The participant's account balance is reduced by the amount of the remaining outstanding principal. The participant does not receive any of the interest that was accrued on the deemed loan. In effect, for the participant with an earmarked loan, the participant bears the investment loss applied against this accrued interest. If the loan was not earmarked as an asset for the participant, the plan bears the investment loss. Let's now consider what happens if the participant remains active and begins making loan repayments for the deemed loan: The plan begins to credit repayments of principal and interest against outstanding balance of the promissory note that includes the interest that accrued after the loan was declared a deemed distribution. The amount of the deemed distribution is considered as after-tax basis for the participant. The interest on these repayments is treated no differently that the way interest was treated before the deemed distribution. It is interest received as income to the plan. The interest repaid by the participant does not create additional basis in the account (just like how income on after-tax contributions does not create additional basis for the participant). Some loan policies may address the plan accounting which can impact the accounting of the above scenarios, but these policies should not create additional basis for the participant. Practitioners who have many, many years in the business may remember when interest on personal loans, credit card interest, and interest on plan loans were all deductible. Those were the days where loan interest was the equivalent of a pre-tax deferral.

I am glad that you owned up to being unable to explain why interest payments on both defaulted and undefaulted loans, all originating outside the plan, would have different treatment for tax purposes once paid to the plan by the participant. I am sympathetic to the additional complexities for recordkeeping, but I think that treating the interest as “pre-tax” in the plan as is all undefaulted plan loan interest would be simpler compared to the alternative. However, I have never had to do recordkeeping, so I do not know how accounts are best set up to track sources and earnings. The basis of the repaid defaulted loan alone is a monkey wrench in most plans. Interest on a regular plan loan does not smell like a deferral, though much has been argued about how plan loans are more or less tax favored in the repayment. I haven’t seen that argument in a long time and hope to never see it again.

with Bri's #3 - put a clause in your engagement agreement that the client idemnifies you for any <2023 issues.

I have dealt with this numerous times when the client said "I do not like it". My response was, "you knew this and were told minimum 3 years (some push to 5 years), committed to it in writing." "If you want to shut down because you do not want it and not stick around for 3 years, then either go away or provide me a letter stating that you are voluntarily terminating the plan against TPA's advice and take full responsibility for any action that may be brought against you by the IRS". As an alternative, I tell them to freeze the plan, stick around for another year or so and then terminate but no guarantees that IRS, upon an audit, will be happy about it. Of course, a financial instability that can be backed up is no issue, easily defendable, life happens. This biz became the ultimate CYA.

Not a lawyer but all TPAs have E&O insurance for a reason. We are required to act in a professional manner and can't be negligent and just say, "well the PA has the only legal responsibility". But as noted this is for a lawyer to opine on if it is worth the legal fight.

Loss of the Section 125 cafeteria plan safe harbor from constructive receipt for the HCPs-- Prop Treas. Reg. §1.125-7(m): (m) Tax treatment of benefits in a cafeteria plan. (1) Nondiscriminatory cafeteria plan. A participant in a nondiscriminatory cafeteria plan (including a highly compensated participant or key employee) who elects qualified benefits is not treated as having received taxable benefits offered through the plan, and thus the qualified benefits elected by the employee are not includible in the employee’s gross income merely because of the availability of taxable benefits. But see paragraph (j) in §1.125-1 on nondiscrimination rules for sections 79(d), 105(h), 129(d), and 137(c)(2), and limitations on exclusion. (2) Discriminatory cafeteria plan. A highly compensated participant or key employee participating in a discriminatory cafeteria plan must include in gross income (in the participant’s taxable year within which ends the plan year with respect to which an election was or could have been made) the value of the taxable benefit with the greatest value that the employee could have elected to receive, even if the employee elects to receive only the nontaxable.

Very few contracts are bulletproof, but is it worth the cost and headache to maybe be able to shift some of the burden to the prior service provider? I agree with Lou, refer them to outside legal counsel. Also, consider that there are probably three sides to the story: the client's side, the TPA's side, and the truth.

1. Run? 2. VCP? 3. Do it right going forward and pray they don't get caught? Some accounting tricks might mitigate the problems (count the late deposit as being for "next year" such that maybe only 1-2 years are totally unfixable based on timing) good luck!

Lou S: I am going to take an uninformed and unresearched shot at guessing that interest payments on the defaulted and taxed loan are “pre-tax” amounts, just as are regular plan loan interest payments, and also earnings on other after – tax amounts, such as voluntary contributions (excluding Roth).

Refer them to their legal counsel for any such questions unless you are an attorney. Tell them it is outside the scope or your services or expertise.

If it was paid to the participant then the participant will receive the 1099-R. If it paid to the spouse as beneficiary then the spouse will receive the 1099-R. Not exactly your situation but close enough to illustrate - participant who is in RMD status dies during the year - Example 1, participant received full RMD before dying then spouse rolls over remained before 12/31. Two 1099-R one to the participant for the RMD with code 7 under their SSN and one to the beneficiary under their SSN with code 4G for the death benefit rollover. Example 2, participant does not receive RMD before death. Spouse beneficiary takes RMD then rolls over remainder to IRA. Two 1099-R both to the beneficiary under their SSN with one with code 4 for the RMD and one with code 4G for the death benefit rollover.

Yes, I agree that the accrued benefit has to be limited to 415. However that does not restrict the hypothetical account balance.

That is my recollection as well. No additional taxable income at time of offset. Which brings up an interesting question that I've never had to deal with in real life since I have not had a participant default and then later pay back. The previously defaulted loan amount is clearly after tax basis . If the additional accrue interest is also paid, as required to retire the loan, is that also after tax basis or is that portion considered pretax earnings subject to income tax when distributed?

Confirming - SB gets prepared/signed and provided to plan sponsor but is not filed, and a first and final EZ filing would be required. On the form there are check boxes for first and final as well as a line to disclose the effective date of the plan, so it could very easily be flagged for IRS scrutiny. And if the situation is as described, plan sponsor changed their mind after an initial tax deferral, that is precisely what IRS does not like, as we all know.

It's not taxable at time of offset. Which means your second sentence is accurate; it is only used for applying limits (and in fact the loan exists so if the limit is one per participant it counts as a loan and another one can't be taken).

Agree with QDROphile, the plan document currently contains language related to the death benefit. At a minimum, the spouse would need to receive 50% of the J&50 survivor option. Sometimes the spouse has the option to take this as a lump sum, but it would only be about 45% of the original lump sum value. Many plans, especially "small plans", contain a more generous death benefit. In small plan land the most common death benefit is the present value of the accrued benefit, which in essence is the same as the lump sum that was going to be paid to the participant. Check the plan document, your answer is there. If is the ERISA minimum (50% of the J&S) and the sponsor wants to pay the full lump sum, they can always amend the plan to provide it. You also need to deal with the MRD issue, which likely involves retro payments to the estate, with some tax implications that are beyond my pay grade.

Plans do not run on undocumented intentions. You say there are no relevant documents submitted. What does the plan (and relevant participant documents, such as beneficiary designations) say about payment of benefits on the death of the participant, taking into account that the participant was subject to required distributions in 2023?