Funding a Profit Sharing Plan

[Guest Kala]

Under Treas Reg 1.401-1(b)(2) it states that merely making a single or occasional contribution from employer profits does not establish a plan of profit sharing. To be a profit sharing plan, there must be recurring and substantial contributions out of profits for the employees. In the event the plan is abandoned, the employer should promptly notify the distric director, stating the circumstances which led to discontinuance of the plan.

My question is this: we are trustees for a profit sharing plan that has not made a contribution since we took it over in 1997. At what point is the plan considered abandoned? Should it be terminated? What if they decide to make a contribution for 2003? Does anybody know if there is a clear guideline that is used to make this determination? The employer is working on restating the document for GUST/EGTRRA.

Thanks for your help!

[david rigby]

Seems like a big leap to go from no contribution in several years, to "abandoned". Does the plan sponsor still exist? If so, "abandoned" seems pretty strong.

[Guest Kala]

Yes, the sponsor still exists, but we are concerned because the Pension Answer Book says that a profit sharing plan is not permanent unless contributions are "recurring and substantial" and referred us to the mentioned Treas Reg 1.401-1(b)(2). The treas reg is where we found the term "abandoned". This made me question what they consider recurring and substantial.

[Mike Preston]

There are no hard and fast rules out there. So, you might want to let the client know that there is this issue that they need to get resolved. Your legal department needs to follow the rules, so it needs to get the issue resolved and guide the process. If the net result is that the plan is considered to have violated the substantial and recurring requirements, then the plan participants will be 100% vested at that point. That time might have been in the past. If so, then certain distributions might have been made which were less than the employees' vested interest in the plan. That is the real exposure here. You, as Trustee, need to ensure that you have no liability and that is hard to do once you have been made aware of the situation, even if you are a directed Trustee with respect to administrative functions, which is likely.

I have heard that a 3% of pay contribution once every 3 years will ensure that the plan doesn't violate the rule.

I have also heard the IRS say on occasion that if the entity in question has no profits and the plan document requires profits that an interval of 5 or 6 years might not trigger the issue.

Obviously, there is a lot of middle ground that can go one way or the other.

[Belgarath]

The following excerpt is from IRS Announcement 94-101, and their audit guidelines. This is just an indicator that they might investigate more closely - I agree completely with Mike that there's a lot of gray area, and "facts and circumstances" determination. Also, I do not know if IRS has updated their audit guidelines for this issue.

IRS-ANNCMT, PEN-RUL ¶17,097N-44, IRS Announcement 94-101, I.R.B. 1994-35, August 29, 1994., IRS plan examination guidelines , (Aug. 29,

1994) PART 01 OF 02.

(2) Discontinuance of Contributions

(a) IRC 411(d)(3) requires that, in the case of a plan to which IRC 412 does not apply, upon complete discontinuance of contributions under

the plan, the rights of all affected employees to benefits accrued to the date of such discontinuance, to the extent funded as of such date, or the

amounts credited to the employees accounts, must be nonforfeitable.

(b) A determination that contributions have been discontinued and the date upon which such discontinuance occurred requires a

consideration of all the relevant facts and circumstances. See Reg. 1.411(d)-2(d).

© A discontinuance of contributions may occur even though some amounts are contributed by the employer under the plan if such

amounts are not substantial enough to reflect the intent on the part of the employer to continue to maintain the plan. A discontinuance becomes

effective, and full vesting will become applicable, not later than the last day of the taxable year following the last taxable year for which a

substantial contribution was made under the plan.

Note: If the employer has failed to make substantial contributions in 3 out of 5 years, and there is a pattern of profits earned, specialists

should consider the issue of discontinuance of contributions.