How soon is it necessary to have a non-zero balance in the trust for a

[Alf]

In order to have a valid trust under state law, the trust must have a settlor, corpus, etc. . .

Therefore, a trust will not legally exist until some minimum level of contribution is made (we usually say $50) and in order to be tax qualified under Code section 401(a), every retirement plan must have a trust.

[John A]

I have heard that many practitioners make sure there is a small balance (like $100) in the trust for a newly established plan by the end of the first plan year. Is this a legislative requirement (if so, any cite?)? Or is it possible to establish the plan and either establish the trust with a zero value initially, or establish the trust at the time when the first contribution is made to the plan. Any help regarding the trust requirements when setting up a plan would be appreciated. Thanks.

[Dave Baker]

I think most states provide by statute that a trust does not "fail" merely because it does not have a corpus, if the terms of the trust agreement otherwise include the elements required to form a trust under state law.

At one time the IRS was willing to allow an accrual basis taxpayer to wait to contribute anything to the trust fund until the due date for making the first plan year's contributions (which would be after the end of the first plan year), but was unwilling to allow a cash basis taxpayer to make the first plan year's contribution some time after the end of the first plan year. But I think the IRS lost that argument in court and later acquiesced. See Dejay Stores v. Ryan, 229 F.2d 867 (2d Cir. 1956) and Tallman Tool & Machine Corp. v. Commissioner, 27 T.C. 372 (1956), acq. 1957-2 C.B. 7 (were those cash basis taxpayers?).

Anyway, Revenue Ruling 81-114, 1981-15 IRB 7, makes it clear that for both cash basis and accrual basis taxpayers, "deductions are allowable under section 404(a) of the Code for contributions paid after the close of the taxable year, but within the time prescribed for filing the employer's income tax return for the preceding year, even though the employees' trust did not have a corpus at the close of the preceding taxable year."

It is true that the IRS requires that the trust be valid under local law, and maybe there's a state in which the failure to have a corpus will cause the written trust agreement to fail, but I'd be surprised.

Some practitioners insist on the $100 by year-end as a precautionary matter, for purposes of proving to the IRS, if it's ever questioned, that the plan was timely adopted. Once there is an account established at some financial institution in the name of a trust, that's awfully strong evidence that the employer did in fact decide to adopt a plan and that the trust agreement that purports to be dated and signed before the end of the first plan year was in fact signed on the date it says it was. But I wouldn't be worried about the IRS attacking the qualified status of a new plan merely because the trust didn't have any corpus by the end of its first year.

[richard]

I agree with Dave Baker's comments in his final paragraph.

While we do not "insist" on money being contributed before the end of the year (especially with a plan being installed in the last week of December), we "strongly recommend" that a contribution be made. (As a practical matter, we are almost "insisting.)

Never had any IRS problems with the few plans that had initial contributions made after December 31.

[Lynn Campbell]

For a new Plan to be in existence for calendar year 2002, are board minutes re establishment of new plan adequate, or must plan document itself be signed by 12/31/2002?

[mbozek]

The IRS requirement under Rev rul 81-114 is that the plan be adopted by the end of the employer's tax year (In fact there are rulings that permit adoption less of than a complete plan) and that contributions be remitted by the date for filing the tax return with extensions. Many plans are adopted on Dec 31 without the time to make any contribution. I have never had the IRS review a newly adopted plan to see if a minimum contribution has been made by year end. Rev. Rul 81-114 was issued to create a consistent requirement for adoption of a qualified plan without regard to whether state law requires that a trust have a minimum corpus.

[jpod]

MBOZEK is correct. There must be a plan and a trust agreement (or an insurance or annuity contract, if the plan is not funded by a trust) in effect before the end of the first taxable year for which deductions will be claimed. If there is no corpus by that date, the IRS doesn't care, even if it might not be a good "trust" under local law as of that date due to the lack of corpus. I don't recall, however, if there is a ruling backing this up.