SEP Short Plan Year

[Guest CJDwyer]

Can a SEP have a short Plan Year?

1. Could a company start a SEP part way through an initial year and only fund on compensation earned from some point during the plan year and forward?

2. Can a company terminate a SEP during the plan year? This case is a SAR-SEP. So they want to stop deferrals at 6/30 and do all the testing on the short period.

Thanks for any feed back.

[Gary Lesser]

Not really, although a fiscal plan year can be changed to the calendar year. Code Section 415 limitation years can be changed. But, regulations require that contributions be tested on compensation for the entire year. The 125 percent ADP test is also based on compensation for the plan year. It is unclear whether the $160,000/200,000 compensation cap has to be prorated. No guidance on issue. Any one who would have entered the plan during the full plan year would also have to be considered. Once terminated, it is unclear whether a SARSEP can be readopted (my guess is "no"). Hope this helps.

[Gary Lesser]

Just a follow up.--

For a QP, the $250,000 limit under 401(a)(17) is prorated. [see http://www.mhco.com/library/Articles/2007/...ear_020907.html] That section does not apply to SEPs. The SEP compensation $200K+ limit is governed by IRC 408(k)(3)©.

However, the 415 limit is prorated if the limitation year is changed to less than 12 months. If that occurrs, then 100% of gross compensation for short plan year and $50K limit for 2012 limit on number of months in short plan year, becomes the limit. SEPS are subject to Code Section 415. The limitation year is the calendar year unless another 12-month period is designated in the plan document. (Nearly every plan will designate the plan year as its limitation year.)

So, if a CY SEP plan were made effective on January 1, not terminatred, or LY ameded, there would be no change to the limitation year under Code Section 415. [see I.T. Reg. Section 1.415(j)-1] It speaks about terminating a plan before the end of the year, but not about starting it in November for a new employer. See, too, the IRM at http://www.irs.gov/irm/part4/irm_04-072-007.html (portion below)

Internal Revenue Manual [4.72.7.3.2.2 (06-14-2002)]

Short Limitation Year ...

"(4) The short limitation period requirements apply only to changes in the limitation year.--For a new participant, the dollar and percentage of compensation limitations in effect for their first limitation year, even if participation commences during the year, is always an entire year's dollar limitation and the applicable percentage of an entire limitation year's compensation, including compensation prior to participation (similarly for those who cease participation during a limitation year or for plans that begin or terminate during a limitation year). "

Thus, it would appear that 415 compensation would not have to be prorated unless the limitation year were to be changed (i.e., be less than a 12 calendar month period). A change could occur by plan design, amendment, or termination. See, too, Section 7 of the SEP LRM The plan will generally define compensation on an annual bases, e.g., as W-2 compensation. If the compensation for any limitation year is less than 12 months, then proration is required.

Hope this helps. Please contribute your thoughts.