Establish plan with a rollover only?

[Guest tracys]

A broker brought us an "owner only" client in 2002. She funded the plan with $41,000 prior to year end and then failed to show any income (a net loss on Sched. C). An ERISA attorney advised us, verbally, that this plan basically never existed - that you must have some compensation to fund the plan with some sort of contribution in order to create a valid plan/trust.

No plan, no penalties - all good news until the broker informed us that the contribution was commingled with a rollover that she'd also put in the plan in 2002.

Legal dep't of the brokerage firm says that our "plan is non-existent" theory is no longer valid because the plan was funded (and therefore established) with a rollover deposit. They do not want to "undo" the rollover.

Question is: Can you establish a plan with nothing but a rollover in the first year?

And I'm happy to hear any thoughts on the overfunding problem. We had this happen with a few owner only's (showing net loss after already funding) and have heard a variety of opinions on how to handle.

[MJ Hartman]

I've seen lots of plans set up that only have rollover deposits in their first year or 2. Mostly for new co.'s that have owners getting plan distributions from prior employers and setting up a plan in their new co. that will have a loan provision so they can borrow against their rollovers.

[mbozek]

Maybe you ought to ask the attorney on what basis the plan never existed. Rev. Rul 81-114 states the requirements for establishing a plan. If the employer has no income or profits then there is no tax deduction for a contribution but that does not mean the plan is not in existance if it is adopted before the end of the year. Also a plan that accepts only rollovers can be a qualified plan such as mp plan which has 0% employer contributions.

Finally the contribution can be refunded if it was conditoned on its deductibility under IRC 404(a). See if the plan year can be changed so that it ends in a subsequent tax year of a the employer when a tax deduction can be taken.

[WDIK]

Maybe you ought to ask the attorney on what basis the plan never existed.

On the basis his advice was verbal and not written?

[Guest tracys]

The broker & client preferred the "free" flavor of legal advise in spite of our disclaimer on it. You can lead a horse to water....

Changing the plan year could solve the problem... but is a non-calendar plan year end do-able for a self employed? Assuming her CPA can provide a net income calculation for this time period.... ?

Also, it is my understanding that the provision of 404(a) allowing for a refund of contribution conditioned on deductibility only comes into play in rather limited circumstances and, seemingly, requires a formal disallowance from the IRS.

[Belgarath]

Take a look at Revenue Ruling 91-4, Revenue Procedure 90-49, IRS Notice 89-52 Q&A 16, and PLR 9144041, which provide additional information on this subject. (Not certain if all these references are still valid - just some notes I jotted to myself when looking into this question quite a while back)