Section 404 excess and plan termination

[Sully]

A self employed dentist shut down his practice in July '05 and is in the process of terminating his profit sharing plan. There are no other participants in the plan besides him.

He has already funded the plan for 2005 and he will exceed the 404 deduction limit by $6,000. Since he will not have any future income he has no way of using up the excess contribution. Do you think this excess contribution could be returned to the employer based on a 'mistake of fact'?

Thanks in advance for any responses.

[Effen]

Could you provide more details on the $6,000 excess? Exactly how was it determined?

What was the "mistake in fact"? Didn't he know the amount of his compensation when he made the deposit? Sounds more like "ignorance of fact".

You will also need to check the language in the Plan document. Plans often contain language relating to non-deductible contributions.

[Sully]

His CPA told him he could make a $3,000 catch-up contribution for 2004. He contributed that $3,000 in 2005.

His CPA also told him he could make a $3,000 catch-up contribution for 2005. He contributed that $3,000 in 2005 also.

Last time I checked you could not make a catch-up contribution to a straight profit sharing plan. Also, the above amounts were above and beyond the 25% of pay 404 limit.

The plan document says the following: 'In the event that a contribution made by the Employer under this Plan is conditioned on deductibility and is not deductible under Section 404 of the Code, the contribution, to the extent of the amount disallowed, must be returned to the Employer within one year after the deduction is disallowed.'

[Effen]

Catch-up contributions are employee $s, not employer $. Therefore, I don't think he has an employer deduction problem, but he has has a personal deduction problem.

Maybe he also has a problem as the Trustee for accepting 401(k) money into the Trust when the Plan didn't contain proper language.

Interesting issue. Maybe you should ask him to check real hard in his files and he just might find that amendment that added the 401(k) option. Even if he found it, it sounds like he still would have a $3,000 problem since he contributed both catch-ups in 2005.

Sounds like the accountant may have some 'splaining to do.

[Guest Pensions in Paradise]

Based on the fact that the $6,000 exceeds the 404 limit, the $6,000 must be returned to the employer in accordance with the plan language you cited.

Now here's the twist. If the dentist truly wants to maximize his contribution for 2005, he can restate his profit sharing plan into a 401(k). Then he can make a catch-up contribution of $4,000 for the 2005 plan year.

[Effen]

How is this a 404 problem? Catch up contributions are not employer contributions. The employer already took the deduction on the payroll side. It is compensation, that the employee chose to defer.

The employee has a problem and Trustee has a problem, but I don't think it is an employer deduction problem.

Maybe the Trustee can simply return the 401(k) contributions since they are not permitted. Did the 2004 W-2 reflect the 2004 catch-up? If so, he may have to re-file his 2004 1040.

[Sully]

No W-2 issued (self-employed). It all showed up on his 1040.

[Guest mjb]

there are two options to consider:

1. Adopt 401k salary reduction amendment before yr end which will allow a 401k contribution for 05. Need to check the rules for adoption of 401k plan as an amendment. Generally participant cannot make contributions to 401k plan before 401k plan is adopted. I dont know if there is a difference if 401k amendment is added to existing plan under the 401k regs that are in effect through 12/31/05. (cant do this next year see reg. 1.401(k)-1(a)(3)(iii)). Secondly, Self employed person are generally deemed to earn money as of 12/ 31 so 401k contributions would be deemed excluded from net earnings earned through 12/31 or contributed no later than the date for filing the tax return. This is a complex option because of the tax issues that need to be reviewed.

2. Return the excess contributions to the dentist after he files his 05 tax return as permitted by the plan on the basis that it will be disallowed as a deduction by the IRS. Dentist could prepare a document stating that the contribution was conditioned on its deductibility. The refund must be sent before the dentist receives his distribution from the plan.