Oh so SIMPLE

Bueller? Bueller? Bump up so that hopefully someone has some information to share on these questions.

Here are a couple of questions. a) can an LLC currently be taxed as a sole proprietorship make a tax election now to henceforth be taxed as a C corporation? b) if so, can the owners be added to payroll for the personal services they render and receive MERP benefits?

I'm hoping someone here has done something like what I'm facing, or can give me some good suggestions at least. A small bank has a 401k plan for its employees. It also has IRAs of customers. Some of the customers' IRAs hold stock in the bank. The bank converted to be an S corporation. That caused UBTI to the IRAs. So the bank's 401k plan purchases the bank stock from the customers' IRAs. To do so, the bank lent its 401k plan $2,100,000 without taking any security. The TPA is telling the bank that the loan needs to be secured to be exempt from prohibited transaction rules. According to the TPA, the loan can be securitized now and 'cure' the problematic loan. This is outside my experience, and am hoping for any direction that anyone can give me.

vebaguru, was your experience splitting the baby with IRS Appeals before 11/15/2004 or since? I ask because the Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004), seems to be fairly significant on this topic.

The attorney's conclusion was that if the advantage to the disqualified person in Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004) was enough to make the deal a prohibited transaction, the advantages to the participant making the side-by-side investment of personal funds and plan benefits would be too. The attorney noted that the outcome would depend on how minor the participant could prove his advantage from the deal to be. The attorney thought that the advantage in Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004) was just that a company would not have to deal without commercial lenders and the disqualified person had a less than 10% interest in that company. If that attenuated of an advantage is enough for a prohibited transaction, then the advantages to the participant who makes a side-by-side investment of personal funds and plan benefits would be enough for a prohibited transaction as well. The attorney was more certain in his opinion that the later loan, to 'rescue' the value of the first, would found to be a prohibited transaction than perhaps the first loan. The client is resisting or disbelieving that the attorney's conclusion is correct and asked what our firm thinks and whether we'd dealt with a situation like this before.

They changed accounting firms about 6 months ago, and the new accountants spotted the concern. The previous accounting firm had given them the okay on the first loan, but no advice was sought when they made the second one.

Here's an update. Our attorney has sent us a letter on this, which basically amounts to this: a-the participant giving the investment direction is a fiduciary-type disqualified person according to Flahertys Arden Bowl, Inc. v. Commissioner, 115 T.C. 269, 115 T.C. No. 19 (9/25/2000). b-a deal between the plan and an arm's length third party can be prohibited transaction if if provides an advantage to a disqualified person, Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004) c-plan loans to companies in which a disqualified person has a minority but 'significant' interest might benefit the disqualified person because such a company does not then have to deal with other lenders, Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004). d-if challenged by the IRS, the disqualified person bears the burden of proving he did not get an advantage from the Plan's deal with the third party, Rollins v. Commissioner, T.C. Memo 2005-260 (11/15/2004). e-H. Conf. Rept. 93-1280 (1974) at 308, 1974-3 C.B. 415, 469, "As in other situations, this prohibited transaction may occur even though there has not been a transfer of money or property between the plan and a party-in-interest. For example, securities purchases or sales by a plan to manipulate the price of the security to the advantage of a party-in-interest constitutes a use by or for the benefit of a party-in-interest of any assets of the plan." The bottom line, according to the lawyer, is whether this participant could prove to a court that he got no personal advantage from the use of the plan assets. My immediate problem is that their 5500 is due next week and no one wants to sign it saying there's no prohibited transaction, because they do not know whether this side-by-side investment would be considered by the IRS to be a prohibited transaction.

I have just become involved with helping a plan that has the following investments, and I am concerned that this is a prohibited transaction. It is a defined contribution plan with individual accounts, over which the participants exercise control in directing the investments. Two of the participants directed that part of their benefits be loaned to an LLC that owned an undeveloped piece of property with a high development potential (before 9/2008). At the same time, the one of the two participants and his wife also loaned other, personal money to the LLC. A single note was issued to the plan and that participant/wife, secured by a 2nd mortgage on the property and personal guaranties from the LLC owners. Then when the financial crisis began in 9/2008, the bank holding the 1st mortgage threatened to foreclose and sale off the property. To avoid that, the two participants directed more of their plan benefits be loaned to the LLC and the participant who had already loaned to the LLC other funds, loaned yet more other funds to the LLC. The new loans were not made in the same proportions as the initial loans. With the additional funds, the LLC paid off the 1st mortgage (at a discount). The LLC and its owners are not themselves disqualified persons or parties in interest vis-a-vis the plan. It yet looks like there could be prohibited transactions due to: 1-Use of personal and plan benefits together to make one and the same investment, i.e. each of the two loans that resulted in the notes. 2-Use of personal and plan benefits in different proportions exacerbating the first note situation in an attempt to save the first note's value. I'm wondering if anyone else has faced issues raised by this situation and what IRS rulings there might be addressing these issues. Thanks.

402g limit is applied on a calendar year basis (January 1-December 31), even as to fiscal plan year plans.

We have been contacted about a type of VEBA being pitched to an employer. We're not sure if this type of VEBA will work or not. Here's how I understand the promotional materials for this VEBA-- This VEBA would be for retiree medical benefits. It works like a defined contribution plan. Each employee will have its own account. When an employee and spouse die without having used all of that employee's account, the remainder is reallocated to the VEBA accounts of the other employees. This reallocation is in proportion to the balances then in the other employees' VEBA accounts. On the other hand, no employee or spouse can receive retiree medical benefits in excess of the balance of the employee's VEBA account. All contributions to the VEBA are made by the employer. The employer adopts a health reimbursement arrangement--HRA--that calls for employer contributions equal to the value of the retiring employee's earned but unused paid vacation time and sick leave. The retiring employee has no choice of a cash out or receiving anything else for that vacation time and sick leave. All other HRA contributions the employer makes to the VEBA are made in the discretion of the employer, like profit sharing contributions to a 401k plan. The allocation of the employer's HRA contributions to the VEBA are not factored upon differences in the employees' compensations. In the VEBA brochure refers to private letter rulings (200452013 9/14/04 and 200549008 9/16/05) in the claim that the IRS allows this. From my quick read, it looks like the IRS has allowed a design like this. There is no ruling cited for the part of the VEBA that is most appealing to our client. While the allocation of the discretionary employer contributions do not depend in any way on differences in compensation among the eligible employees, different numbers of years to retirement are. It is explained that this is like new comparability for profit sharing contributions to a 401k plan. It gives an example of a situation with two employees, the owner at age 56 (9 years to age 65 retirement age) and the other employee at age 38 (27 years to age 65). If 8% earnings are assumed, then of a $100 contribution made by the employer, $20 can be allocated to the 38 year old and $80 to the 56 year old. Both will have $160 in benefits when they separately reach age 65. The brochure explains that there is no IRS ruling allowing for this new comparability factor in the allocation of the discretionary employer contributions, but explains it makes more sense to compare the benefits of each employee at age 65 rather than when money is contributed since Code section 105(h)(2)(B) calls for nondiscrimination in "benefits provided". That makes sense to me, but I would feel more assured if the IRS had ruled on this. Any comments on this type of 'new comparability' VEBA?

If a 401k plan specifies in its adoption agreement that it is safe harbored and the employer will make the match, but then did not give the annual safe harbor notice before the 2005 plan year began, is the matching contribution required for 2005? The ADP/ACP tests would apply because there was no safe harbor notice. But does the plan also have to make the safe harbor match specified in the adoption agreement? Does the employer have to make a contribution equal to 50% of 3% (or actual ADP) and then the match to correct for 2005? The 50% employer contribution is what EPCRS currently calls for if the employee had no effective opportunity to make elective deferrals. Does not notifying employees of the safe harbor match deprive employees of an effective opportunity to make deferrals (or more deferrals) to then be entitled to the match? The employees nevertheless could make elective deferrals even without the safe harbor notice. Revenue Procedure 2008-50 asks for comments about how EPCRS ought to be modified in the future to add a correction for such a failure. The IRS is auditing this particular situation and the agent asserting that 50% employer contribution by analogy and requiring it in addition to the safe harbor match in order to avoid disqualification of the plan. What experience has anyone had with other IRS auditors dealing with this type of situation? Thanks for any information or suggestions you make.

A new-to-us client has maintained a plan that dates back to 1981. It has never received a determination letter from the IRS. Originally, it was a money purchase pension plan. Apparently, no TEFRA/DEFRA/REA amendment was timely made. This was discovered in the early 1990s, as part of the TRA '86 restatement process. I'm assuming that in that pre-EPCRS era, the provider did not have the option of a plan document failure fix with minor penalty as there now is. It appears that provider simply restated the plan as a standardized money purchase pension plan in the early 1990s to give the plan reliance on that provider's standardized prototype notification letter, per Rev Proc 89-13, section 11.02. Shortly thereafter, the plan was restated again, but this time as a standardized profit sharing plan. Again, reliance on provider's notification letter from the IRS. (This followed so closely on the heels of the restatement to the standardized money purchase pension plan that it appears that step may merely have been made by the prior provider to lay claim to Rev Proc 89-13, section 11.02 reliance.) The plan was timely restated for GUST. Yet again, reliance on provider's notification letter from the IRS. The employer recently hired our firm to restate for EGTRRA. The plan design changes now wanted require that the prototype used be in the non-standardized form. If we prepare an IRS Form 5307 application, from which notification letter would we have to provide later documents? or would it be from plan inception? The argument for the TRA '86 notification letter is that if a determination letter application (Form 5307) had been made in the later 1990s, that TRA '86 notification letter and adoption agreement (and amendment in the interim until the application was made) was all that would then have been required. The argument for documents from plan inception is that beginning with the GUST restatements, reliance on adoption of a standardized prototype's notification letter did not count as the most recent determination letter for the plan. Or, would it simply be better to prepare a document failure VCP application at the same time as now making a determination letter application?

Mucho gracias, Senors Norman and Bird.

I am working with an employer that is using a new prototype document that specifies the 'Participant Group Allocation Method' under LRM 94 language. The adoption agreement specifies that the employer will specify the groupings for the plan year by the time it makes the contribution. After running several different grouping scenarios, it looks like cross-testing is not as good for the plan year ended April 30 as would a simple profit sharing allocation of the same percentage of earnings for everyone. Due to some personnel changes in this small company (10 employees, counting the two owners), the owners are almost all younger than the 7 other employees. May the employer specify one grouping of all 10 employees under the LRM 94 language, allocate the entire contribution within that one group in respect to earnings, and not be discriminatory because all eligible employees are receiving the same percentage of earnings? Or must we use cross-testing to show discrimination, in which case the single grouping idea would cause the plan to be discriminatory?

A sole proprietor had a SEP IRA plan. She died in 2008, at age 78. Her husband was the death beneficiary and about the first of December requested a payout equal to the 2008 required minimum distribution for his dead wife. The brokerage house refused, saying he must first set up rollover IRA in his name as surviving spouse and take the required distribution from the rollover IRA. The surviving husband refused to do that, on advice of legal counsel that the 2008 required distribution for his dead wife was not eligible for rollover and if rolled over, would cause a 6% penalty. In addition, the withdrawal from the rollover IRA would not satisfy the 2008 required distribution for the dead wife. The brokerage house held tight when this advice was explained to its technical compliance and then legal departments. December 31 passed with no distribution being taken, and now a 50% penalty applies. Should the husband notify the IRS about this situation? Is the brokerage house that refused the withdrawal request responsible for paying the 50% penalty?

That is the question. Having two separate elections per year for medical FSAs, one in August for the general FSA to apply September 1 thru next August 31, and another in December for the vision co-op only FSA to apply for the following calendar year. Each FSA would run 12 months in length. The entire amount of each FSA would be available from the first day of its 12 month period. No mid-year decreases of an FSA would be allowed. Expenses incurred before the 12 month period of either FSA would not be eligible for payment from that FSA. Election would be required before the 12 month coverage period begins. Those aspects all sound fine and dandy. The concern is whether the staggered years means that with respect to one of the FSAs, the ability to elect the other in the midst of the first FSA's 12-month year would amount to a mid-year change of that first FSA, which is not permitted. Unlike the typical mid-year change, though, the mid-year change to the first FSA by reason of electing the second FSA would not just be to the end of the 12-month period for the first FSA. The second FSA election itself would last for a 12-month period, just a different 12-month period than the first FSA. The proposed regulations seem fine with differing 12-month periods between medical FSAs and dependent care FSAs, for example. Those are different categories of expenses, though. Does the fact that the vision co-op FSA is limited to just one type of medical expenses, vision related ones, and may only be used at participating optometrist shops differentiate it enough from general medical expenses that are covered under the general medical FSA to allow for different 12-month periods? The vision co-op FSA is only available from the vision co-op on a calendar year basis.

This is a question about determining the earned income of a partner. The partnership has determined that the partners do not actively participate. They meet from time to time as a board to discuss and decide issues that have come up in the partnership's business. The partnership reports on K-1's the income to its owners as passive, not subject to self-employment tax. One of the partners reports on his 1040 that he materially participates in the business of the partnership for the year and pays self-employment tax, so that he could accrue a plan benefit. The other partners report the K-1 income as passive on their 1040s and do not pay self-employment tax. The partnership does not take into account as plan compensation what it reported to any of the partners on the K-1's as passive income. The partner that claimed material participation and paid self-employment tax wants his income to be earned income under 401© and considered as plan compensation so that he can accrue plan benefits. He points to some proposed regs that show as an example that attending regular business meetings of the partnership meets the de minimis activity level required. The other partners are concerned that if the plan were to accommodate him, it would call into question their treatment of the K-1 amounts as passive income and trigger self-employment tax for those other partners. Some of them spent more time attending to the partnership's business (i.e., attended more of the management meetings) than did the partner that chose to pay self-employment tax. The partner that paid the self-employment tax insists that if he is not allowed to accrue a plan benefit, he will file amended returns to claim a refund of the self-employment tax and that could be what triggers an audit of the partnership and the partners on that issue. As the plan administrator, the partnership must decide if the partners' earnings are "with respect to a trade or business in which personal services of the taxpayer are a material income-producing factor". IRC 401©(2)(A)(i). What should the partnership, which is controlled by the 'passive' partners, do?

The co-op provides the plan document, SPD, sign-up sheets, etc. The co-op claims IIAS requirements are met, explaining that the cards may only be used at the participating optometrist's shops which have, relatively speaking, very limited types of services and products (vision) that they've coded for IIAS in the IT system the cards use. No membership fee or annual fee of any kind. The co-op optometrists are sponsoring the vision card FSA plan for its marketing purposes. The promoters are explaining that an employee that doesn't want the co-op provider plan may forego electing it and use the employer's "regular" medical flex accounts for purposes of electing and paying for other vision expenses, following its claim and substantiation requirements.

An employer's fiscal years end 3/31. The employer has a cafeteria plan with medical FSAs, and the plan years end 3/31. A local "co-op" of optometrists are offering a 'vision card' to employers that amounts to a flex account, but may only be used at one of the co-op optometrists. The co-op has an IT system that will track usage of the vision card, keep the supporting documentation, produce statements for the employee and employer, and invoice the employer periodically. All the employer needs to do is pass out SPDs and sign up sheets. This employer wants to add these vision card FSAs in addition to the general use medical FSAs in its cafeteria plan, as vision insurance is being dropped. The challenge is that the co-op only offers these vision card FSAs on a calendar year basis. Each March employees would elect their new medical FSAs for the upcoming plan year to begin April 1, but then they'd also be able to elect each December for the vision card FSA for the upcoming calendar year. May the employer adopt the vision card FSAs as a second cafeteria plan, along side the PYE 3/31 cafeteria plan with a general medical FSA without violating the rules against mid-year election changes? If the two programs would in essence be considered just one, then I think the answer is no. If the two cafeteria plans would be treated distinctly as two, then I suppose that this might work.

Do the EGTRRA prototypes as being approved by the IRS include provisions for Final 401k Regs or will this require an immediate amendment like the Final 415 Regs?

Plan has a loan program that limits the amount that may be borrowed to 1/2 of the vested balance, and requires a pledge of the vested benefits as security for loans. The loan program requires 5 year repayment period, unless to acquire a primary residence. Then it may be longer. If the loan repayment period is longer than 5 years, i.e. to purchase a primary residence, must the loan be secured by a mortgage on the primary residence being purchased or will a pledge of the vested benefits be sufficient?

Employee participates in 401k safe harbor (matching) plan for two years, then quits with vested benefits. She re-hires on a year later (there was a break in service year). Now she only works 200 hours per year. On re-hire she is allowed to participate at the next plan entry date. She makes elective deferrals and receives the safe harbor match. If continuing to incur break in service years, will she become ineligible after the 5th break in service year occurs? If she had not made any elective deferrals (and otherwise had no vested benefits) when she quit before re-hiring, would the answer be different?

As to the compensation deferred under the plan prior to 2005, if there has been no material modification since Oct 3, 2004, then that should be grandfathered passed 409A. As to the compensation deferred under the plan from 1/1-6/30/2005, it is subject to 409A and should have been handled in a way that was a good faith interpretation of the interim guidance. If so, then you do have through the end of 2008 to amend to bring the document into compliance as it affects these 2005 deferrals. If those 2005 deferrals have not been handled in a good faith interpretive way, then you have a violation and the income taxes + 20% excise tax + interest.

A stock appreciation right vested in 2006 and was not in compliance with 409A. (It is subject to 409A because it doesn't fit the reg 1.409A-1(b)(5)(i)(B) exception to deferred compensation). Part of the violation included the employee having the right to elect and in fact electing to postpone payout until 2008. For 2006, there was 409A income subject to withholding and reporting in an amount equal to value in 2006 (stock value less exercise price), when the employee first had the immediate right to exercise the stock right. However, the employer did not realize its reporting and withholding obligation with respect to the amount that vested in 2006. The stock price has gone up since 2006. Does the employer have to report and 'withhold' on the 2007 increase? or just wait until 2008 when actual payout will take place? Also, any suggestions about how to handle the missed 2006 reporting and withholding at this late date?

As I read the FAB, truly 'supplemental' policies are excepted. Individual policies for major medical could yet be part of a group health plan, subject to the health reform requirements for group health plans and that often are not in those individual policies. It depends on the level of involvement of the employer in choosing the individual policies, cutting a premium price break for its employees, or bearing part of the expense of the premiums.