SELF EMPLOYED ISSUE

[Guest Big Al]

A local ERISA attorney is taking the position that a self employed individual is limited in how much he can benefit from a New Comp plan in any given year.

In particular, he feels that a partner's New Comp contribution counts towards his 402(g). Thus a partner's deferral + New Comp can not exceed $15k for 2006.

I think he is full of beans. Has anyone had a partnership or sole prop plan audited and has this issue came up?

thanks

Alan

[Tom Poje]

This is an issue being hotly debated. some IRS agents have taken this position. ASPPA is fighting this interpretation, hopefully there will be some more information on this shortly.

[rcline46]

Since TEFRA I don't see how the IRS can challenge since that created parity between the old Keogh plans and plans of corporations. That is why the definition of Earned Income is in the plan documents. The fact that a self employed person (sole props and partners) could get the full profit sharing limit has not been in question for over 20 years now. Congress has long ago spoken and the IRS cannot change it!

[jpod]

For an unincorporated sole proprietor (i.e., not a partnership), I think the attorney is correct, at least based on my assumption of the type of new comp. plan you're talking about. You shouldn't use a new comp. plan for a sole proprietor if that leaves the sole proprietor with any discretion to determine the level of contribution for himself or herself.

For a partnership, in my view it is a question of whether or not the appropriate governance is in place. In other words, if each partner has the right to designate how much he or she wishes to contribute under the new comp. plan, then in my view that is a CODA. If, however, the partnership's management committee, or the partnership as a whole, has the sole responsibility and authority to approve the contribution levels for all plan participants, then there should be no CODA, even if each partner is free to make a non-binding request or suggestion as to the $ amount he or she should contribute for the year.

I don't see how TEFRA's creation of parity has anything to do with the issue of whether or not a new comp. plan is really a de facto CODA.

[Bird]

I've never had a problem and can't imagine not getting it settled, quickly, if it's raised on audit. It's just plain wrong.

[Guest Old Lady]

I can't see why the IRS thinks that self-employed people are any different from corporate anyway. I agree about the intent of TEFRA to recognize that fact.

Whoever is in charge of the company makes the decisions for employer contributions. Doesn't matter if you're C-Corp or Sub-S owner - still making the decisions on how much the "employer" puts in. Even in a publicly-held corporation, my guess would be that many times the President or CEO is really making the decsions on his/her own contribution even if someone else actually has the "official" approval to do it.

[jpod]

Old Lady:

In the case of an unincorporated sole proprietor, the participant and the "employer" are the same human being. In the case of a one-owner corporation, it is true that the participant is also the same human being that controls the corporation, but there is a corporate form that separates them. Form over substance? Perhaps, but the separate "existence" of a corporation is a concept that has been respected for centuries.

[Blinky the 3-eyed Fish]

Jpod, you reference a new comp plan, but what about just a plain profit sharing plan with a pro rata allocation? What about a defined benefit plan that has a range between the minimum contribution and the maximum deductible contribution? What about any partnership that has any plan?

It's the same argument for all and a ridiculous one if you ask me.

Separate existence of a corporation is a legal concept but one that is no different in determining pension contributions for owners. The fact that this is an issue at all boggles my mind.

[jpod]

Blinky, interesting observation about profit sharing plans, etc. The distinction I would draw is that is as follows.

On the one hand, there is no way one could legitimately argue that the enactment of subsection (k) of Section 401(k) suddenly caused all discretionary profit sharing plans maintained by self-employed persons to become CODAs subject to the 401(k) non-discrmination rules and, years later, the 402(g) limits.

On the other hand, in the case of a new comp. plan, where you have different groups, there is the ability to apply an element of discretion that does not effect all participants in the same way. Therefore, if the decision-maker is also a participant, that tends to look more like a CODA within the meaning of 401(k) than a plain vanilla profit sharing plan.

I realize that many at the IRS simply do not like new comp. plans and attack them in a knee-jerk manner, but I do think there is some merit in questioning their validity in the context of an unincorporated sole proprietorship.

[Guest mjb]

See reg 1.401k-1a6i- in the case of a partnership a coda includes any arrangement that directly or indirectly permits individual partners to vary the amount of contributions made on their behalf. kapish. Can the partner vary the amount of the contributions?

[jpod]

mjb:

I think most of us are aware of the reg. you cited. In the case of a partnership, if the final word lies with the partnership voting as a whole or a management committee or what have you, a new comp. plan should work, because no partner can individually determine what his or her contribution would be. If you are suggesting that the use of the word "indirectly" means that you have a problem if there is some sort of enforceable understanding among the partners that each partner can decide how much he or she wishes to contribute and the decision-makers will simply rubber-stamp it, I would agree with you. However, that is not the scenario I was suggesting.

[Guest mjb]

I think the IRS position is that the formula must be something designated in the plan, not by a committee whose members can determine their own contribution level or be influenced by their friends. Most pships do not vote by the pship because the SR partners do not want to have the jr partners outvoting them (or knowing how much is being contributed to the plan for them. )

[Guest Old Lady]

Still, the arguments about partners vs shareholders is not real-world. I have been the sole owner or a majority owner in a C-corp for many years. I control the plan. I control the formulas. I control the amount of contribution for everyone. I pay for my own contribution as well as pay for all my employees' contributions (except their own deferrals of course). This is no different than if I had formed my business as a partnernership or sole proprietorship.

If the IRS doesn't like new comparability plans, that's one thing. But to single out partnerships and sole proprietors over shareholders is against parity which was dictated by Congress. Their intent was clearly to eliminate "form over substance" in the case of qualified retirement plans. The self-employed have been around even longer than corporations and they assume liabilities that corporate owners do not have. Congress intended them to be treated equally with corporations in this area. Before that, they had to use Keogh plans with lower contribution limits than corporations.

The other problem here is trying to design plans with no certainty of whether or not they will be challenged by individual agents on audit. Clear directives were the intent of the non-discrimination rules that the IRS finally came up with and that in essence "created" new comparability plans.

[Guest CharlieLaur]

I agree with "Old Lady" --- my mother always told me to respect my elders.

A 50% shareholder in a C-Corporation has as much (or as little) discretion in determining his contribution in a new-comp plan as he would if he were a 50% partner in a partnership or LLP.

However there is no mandate for the IRS to follow reality and, therefore, it would not totally surprise me if the IRS would try to establish a distinction between the corporate world and the non-corporate world. It would depress me greatly but it would not totally surprise me.

[Guest mjb]

The tax law is littered with similar provisions in which an arbitrary line has been drawn (S corp owners cannot participate in an FSA), salary reduction contributions by key employees in a TH plan are deemed to be an employer contribution), married couple who have separate businesses in which they own 100% become a controlled group with each others qualified plan if they have a child, etc.

[AndyH]

The tax law is littered

...

Very effective 4 words!

Maybe our resident archivist WDIK can index that one for future use.

p.s. I had the same reaction as Blinky but jpod provided a very good answer. Here I am complementing everybody; I must have just returned from vacation!

[ak2ary]

Interestingly, the IRS has apparently adopted the position that it will not pre-approve plans (e.g. volume submitter documents) that allow an unincorporated employer to have a new comp pln in which a single participant/owner/partner is his own allocation group. So in a volume submitter plan, at least, a sole prop with employees can not be in a separate allocation class than his employees, if the contribution per class is discretionary

[Guest Pensions in Paradise]

Could you please expand on your comments above. How did you come to this conclusion?

[Locust]

How about this example.

Partnership plan has 3 partners. They get together at the end of the year to decide on contributions. Partner A wants 25% of pay, partner B wants 5% of pay, and partner C wants 1% of pay. The partners decide to create 3 groups of participants who will receive different levels of contributions (group 1 25%, group 2 5% and group 3 1%) and lo and behold!! each partner gets into the group that coincides with the level of contribution he/she wants to pay.

Is that ok? I think it depends on how it is done. First, is it done with a plan amendment or some fuzzy administrative document? Second, is it done before the end of the Plan Year. Third, what are the criteria for setting up the 3 groups? Is it just to accommodate the 3 partners' desired contributions? The approach that causes the least conceptual difficulty would be to adopt an amendment before the end of the year that establishes consistent understandable groups, such as senior partners, equity partners, junior partners, managers, secretaries, etc.

I'm not sure if this is really an issue with the IRS. I can understand the IRS wanting to limit the use of volume submitter plans and protoypes, which receive the benefit of being ok without additional IRS review. If you allowed these types of plans to just have a fill-in-the blank where the groups are designated, you've given free rein to every type of group and every type of designation procedure (ex. "group 1 consists of those persons designated as highest benefit % participants by the managing partner", or worse, "group 1 consists of those employees designated by the managing partners and partners who elect group 1"), and you've basically eliminated the rule that says that allocations have to be determined by the plan document. Personally, I have difficulty understanding how the IRS allows designations of groups that do not have a normal business meaning (such as "Joe and Jill") but it does. With the addition of the 5% gateway contribution, it appears that the IRS has given up on this issue, with the deal being that if you put in 5% for everyone, you can do whatever you want for your control group of employees/partners.

Comparability plans are a great deal for owners, and they deserve it for being such great guys and for sacrificing so much for our great economic system! Get em while you can. However. if owners and their advisors get too greedy, these plans may go away. We'll know when they start writing about them in the NY Times.

[Guest Pensions in Paradise]

I can understand the IRS wanting to limit the use of volume submitter plans and protoypes, which receive the benefit of being ok without additional IRS review. If you allowed these types of plans to just have a fill-in-the blank where the groups are designated, you've given free rein to every type of group and every type of designation procedure

There are already volume submitter documents which have a fill-in-the-blank where the groups are designated. Corbel documents immediately come to mind. In addition, Rev Proc 2005-16 now permits non-standardized plans to contain cross-tested formulas.