Mistaken Profit Sharing Contribution

[Guest ama]

Employer sponsors a profit sharing plan with two participants, both of which are 50% shareholders of Employer and highly compensated. Participant 1 made an irrevocable election not to participate in the plan several years ago. In the current plan year, Employer mistakenly made a profit sharing contribution to Participant 1's account. Is the only option for correction to place the mistaken contribution in a suspense account to be used for future contributions to Participant 2's account? Participant 2 has already received a $40,000 contribution for the current plan year. Is it possible for the mistaken contribution to be returned to the Employer, especially in light of the fact that the mistake was discovered during the plan year in which it was made?

[jpod]

1. Most likely there was no "mistake of fact" here, at least under the very narrow interpretation adopted by IRS. In a two-person-owner plan, you run a great risk of disqualification by relying on the mistake of fact theory under these facts.

2. Was the contribution made after the close of the plan year for which it was intended? If so, why can't you use the excess as an advance contribution for the year IN WHICH it was made?

[Guest ama]

Thank you for your response. The plan is on a 4/1-3/31 plan year and the "mistaken" contribution was made in the current plan year that will end on 3/31.

[jpod]

Well then, since you're still inside the plan year, why can't you amend the plan to let the other owner back in the plan? I doubt that the "irrevocable election" requirement would be violated if the board of directors of the employer resolves to amend the plan to eliminate the irrevocable election option.

I realize that the other owner probably won't get the same amount of up front cash he expected to get, but this is the only way you would avoid the 10% excise tax on nondeductible contributions.

[Kirk Maldonado]

JPod:

My guess is that the IRS wouldn't let you get around the "irrevocable election" rule by the simple artifice of a plan amendment, particularly in these circumstances.

[jpod]

Kirk:

You may be right about how the IRS may view it, but the IRS would be wrong. The "irrevocable election" concept in the regs. deals with unilateral actions by employees. Unless the employee was completely in control of the actions of the corporation, either as a majority shareholder or whatever, the actions of the duly constituted board of directors of the corporation should be respected and not deemed to be a unilateral revocation of the employee's election. The stated facts are that the two owners are 50-50 shareholders, and I guess I'm making the assumption that the shareholder in question is not the sole director of the corporation.