Deduction When Plan Year does not match Tax Year

[Dougsbpc]

Suppose you have a small company (just two 50% partners in LLC) that starts business June 1, 2006. They already have income of $600K each. The tax year is December 31, 2006. Their plan salary already exceeds $220k each.

They could adopt a DB plan with a plan year 6/1/06 to 5/31/07. Question: Given they will have maximum plan salary before 12/31/06, could the DB plan be run on a beginning of year basis? If so, could the full contribution for the 6/1/06-5/31/07 plan year be deducted on the 12/31/06 tax return? It would be contributed by 12/31/06.

Thanks.

[david rigby]

Is there a reason not to use a plan effective date of 01/01/06, and calendar plan year?

Do they want to adopt me?

[mwyatt]

You have incorporation date of 6/1/06, which makes a 1/1/06 effective date a little questionable on the face of it.

[Dougsbpc]

Yes. I dont think we can have a plan effective date prior to when the business was started. Also these two guys both worked as employees for a large company so there is no predecessor service.

Reg 1.404(a)-14© states that if the employer's taxable year does not coincide with the plan year, the deductible limit for a given taxable year is one of the following alternatives:

1) The deductible limit determined for the plan year commencing within the taxable year.

2) The deductible limit determined for the plan year ending within the taxable year.

3) A weighted average of #1 and #2.

In this case, it seems as though #1 would allow the full plan year contribution to be deductible in 2006.

Anyone disagree with this?

[Belgarath]

First, I agree with your scenario that you can deduct the full first year's plan cost for 2006.

Second, I also agree with Pax's observation. I've seen about a zillion plans (give or take a few bajillion) that use this approach. Apparently the IRS publicly stated that this was ok back in 1997 at one of the ASPPA conferences. Plans have received favorable determination letters using this approach, so they apparently don't have any problem with it. However, I don't know of any OFFICIAL statutory or regulatory approval of this method, so the conservative route would be to proceed as you have outlined.

[Blinky the 3-eyed Fish]

They have stated it publicly many times since then as well. I would have no problems with an effective date that precedes the entity starting date.

[Dougsbpc]

What if under the same circumstances the employer had a plan year 6/1/06-5/31/07, tax year of 12/31/06 but paid no salaries until 4/30/07?

We still think the entire contribution would be deductible.

Revenue ruling 90-105 indicates that any contributions related to compensation paid after the tax year would not be deductible, but only with respect to a 401(k) PLAN.