Starting 401(k) mid year, with BOY effective date

[Santo Gold]

A small company was just started in May, 2006, and damn the torpedos, they want a 401(k) plan up and running by 7/1/06.

They want a calendar year plan, but with a 7/1 effective date, which would make their initial plan year a 6 month SPY. The document software does not seem to support having an intial SPY, and as such, there would have to be an amendment before 1/1/07, indicating the plan year as being from 1/1 - 12/31 after the 2006 plan year.

This is what they will likely do, but what if we just drafted the document to reflect a 1/1/06 effective date? We would have the "whole plan year we want". The company wasn't around at that time, but would that invalidate the document?

[WDIK]

http://benefitslink.com/boards/index.php?showtopic=21009

[Santo Gold]

Thanks for that informative link; it pretty much covers the exact situation I have. Sounds like the answer it is "probably" OK to have the effective date pre-date the company's existence. Based mostly on IRS conference opinions.

[Guest zora]

How can a company that doesn't exist have a plan? Make the effective date no earlier than when the company existed. Anything else will only raise questions.

Also, they can't make 401(k) compensation deferrals for money they have already received.

[Belgarath]

It is true that IRS commentary from the podium at conferences is unofficial, but it can be useful.

We have had a few plans set up in the general circumstances described (plan effective date prior to the formation of the corporation) and have expressly noted this in the determination letter requests. In every instance, approval received without any question whatsoever.

So while this may not be necessary in your particular 401(k) situation, if it cures a problem that would otherwise exist, then I wouldn't hesitate to use it. While I grant you that the whole concept seems counter-intuitive, at least to me, I was taught long ago that when dealing with the IRS, accept what is, and not what you think makes sense.

[E as in ERISA]

As long as you don't actually make retroactive 401(k) elections covering compensation prior to implementation of the plan it should not be a big deal. Make sure that the owner is not participating before the NHCEs.

[Santo Gold]

Only HCEs are employed right now, so there is no problem with discrimination.

Question for Belgarath: I'm using an IRS approved prototype document for this plan, and would not normally file for a determination letter. Did you file for a letter solely because of the retro effective date?

[Belgarath]

Santo - nope - this was back in the days before IRS Announcement 2001-77 was issued, and we applied for determination letters on everything. We wouldn't file for a determination letter on a prototype or VS because of this issue now, given that it has always been approved with no problem.

Clarification - we always leave the final decision up to the client, and if they choose to file for a determination letter, then of course that is fine.

[Guest zora]

You all are only thinking about providing consulting advice on plan qualification. It is bad legal advice to tell an employer to backdate any document. Look at all the problems out there now with backdating stock options. You are opening the door for a host of legal problems.

[Guest mjb]

What is being backdated? I thought under IRS rules a plan can always be established by the last day of the plan yr retroactively to the first day, e.g,. adoption on Dec 31 for plan yr beginning prior 1/1. While unusual there is no appearent prohibition against establishing a plan as of a date beginning in a plan year prior to the date the employer is established. No one is suggesting that salary reduction contributions be made before the plan is adopted.

[BG5150]

As long as you don't actually make retroactive 401(k) elections covering compensation prior to implementation of the plan it should not be a big deal. Make sure that the owner is not participating before the NHCEs.

BINGO!

[Guest zora]

For example, if there is litigation two years from now about an employee who was injured on the first day of the job and the first day the company opened, Exhibit No. 1 is going to be a plan document that says "On July 1, 2006 Corporation X adopted this plan effective January 1, 2006." Then the plaintiff's attorney is going to say "So the company had a plan on January 1, 2006, but for six months after that it did nothing to make sure its machines were safe. They made sure they had money, but they didn't care about their employees being safe."

Then the company's lawyer who is now stuck with this plan document has to try and explain to the jurors it was only a legal fiction for plan qualification purposes, but the jurors don't want to understand and don't care because they or their mother or friend just got laid off and they think employers all lie anyway and this is just proof that they lied because they backdated their plan document when they knew they were adopting it six months later.

And all because someone is too lazy to have an initial short plan year.

[WDIK]

Aren't there reasons besides sloth for wanting a twelve month initial plan year?

Your inventive scenario does not give me great concern.