Accounting basis for 5500-EZ?

[Guest winterhill]

Could someone please clarify whether cash-basis reporting is permitted for the 5500-EZ specifically? I'm a sole proprietor, and my search of this forum (where I found nothing explicit on this though between the lines it seemed to be an option) and other sources yielded contradictory results, and I'd be grateful for clarification.

The IRS instructions for the 5500-EZ aren't helpful. By contrast, the instructions for the full 5500 (Schedule I) are clear: pick one basis (cash, accrual, etc.), the choice is yours, just be consistent. But the instructions for the EZ don't discuss accounting basis, and the only reference I find seems vague and contradictory:

"Line 10b. Enter the total cash contributions received by the plan during the year and the contributions owed to the plan at the end of the plan year including contributions for administrative expenses."

That's all it says. That seems like a muddle of cash basis (total received during the year) and accrual basis (owed at year end), so I phoned the IRS's 5500 help line for clarification. The opinion the rep offered was specific and allowed no room for choice. I was told my calendar-year plan's 5500-EZ for 2006 should not include those contributions made during 2006 that were designated for 2005, but should include the 2006-designated profit-sharing and salary-deferral contributions I will be making in 2007 before the filing deadline. (These optional contributions were considered to be "owed".) In short, I must use the accrual basis.

Is this true? Are the accounting basis rules for the 5500 and the EZ really different? If accrual is really the only basis permitted for the EZ, it complicates my reporting, and I'd appreciate input ...

For 2005 (the first year the $100K threshold was reached), I submitted the plan's first annual filing -- on the full Form 5500, only because a copy of the 5500-EZ (for which I'm eligible) wasn't obtainable by the deadline. Following Schedule I's instructions, I chose the cash basis, consistent with my business accounting basis. That 2005 filing reported all contributions actually received during the 2005 plan year (including those designated for 2004) and excluded those 2005-designated contributions which were made in 2006.

So ... if it's true that EZ filers must use accrual-basis reporting, do I need to continue filing the full 5500 for 2006 and future years in order to remain consistent in using the cash basis? Or, if I want to use the EZ going forward, must I now switch horses in midstream and do an amended 2005 filing changing to the accrual basis?

Thanks in advance for any light you can shed.

[JanetM]

Switch to EZ this year if you qualify for it. Use accrual accounting basis. Show receivables for the 2006 year. The purpose of this when the audit your tax returm they will look at 2006 income to ensure you contributions are allowable and deductible.

[Guest winterhill]

Switch to EZ this year if you qualify for it. Use accrual accounting basis. Show receivables for the 2006 year. The purpose of this when the audit your tax returm they will look at 2006 income to ensure you contributions are allowable and deductible.

Janet M, thank you for your reply. To be sure I understand you correctly, I think you're recommending switching to the accrual method in order that the numbers on the 5500-EZ and my 1040 (line 28 and Schedule C) are in agreement each year ... yes? Avoiding IRS scrutiny is a compelling argument. But just to clarify: on the EZ, is the accrual basis required (as opposed to continuing my cash basis precedent and perhaps filing a reconciliation with the form), or is it just the preferred method because it keeps all the numbers in agreement?

My reason for asking: after receiving the IRS help line opinion I'd mentioned, I asked them to submit a research request to confirm that opinion, and an agent called me back this morning. He was clearly taking a "kinder, gentler" approach to my situation, and his opinion was different. He agreed I should switch to the 5500-EZ, but he advised against switching to accrual basis at this point, since my original filing was cash basis. He gave two reasons: (1) if I were to switch to accrual method at this point, the switch could raise a red flag with the IRS because it would suggest a material change in my business; and (2) in cases like this, he said, the IRS is more interested in the most practical solution than in the letter of the law (!). In short, he said to file the EZ but continue using the cash basis. (We didn't discuss any potential disagreement with 1040 numbers.)

My first instinct is to follow what the IRS agent told me, and to cite his opinion in my cover letter. But it appears that either way (cash or accrual), I may attract IRS scrutiny. And because your opinion (which seems closer to the letter of the law) differed from his, I would be grateful for your thoughts on this.

Thanks.

[JanetM]

I don't agree with the advice the IRS rep gave you. IRS is interested in letter of the law, that is why they have tax court and oft time they are on the losing side.

I would advise you to what is right, not just expedient and simple.

EZ instructions say for line 10b: Enter the total amount of cash contributions received for this plan year, including contributions due to the trust but not yet received (receivables).

Crystal clear to me. File the EZ and get on with life. If you get a letter, respond that you were advised the use cash basis and when you read the instructions you found you had not been correct. Offer to file amended 5500 returns and that will be the end of it.

[Guest winterhill]

Thank you so much for clarifying the specific point that I've been trying to pin down!

So, where the EZ 10b instructions say to include total contributions "received by the plan DURING the year" (the IRS's ambiguous word choice), they really mean the contributions "received by the plan FOR the year." Accrual.

I appreciate your advice and the time you took to give it. I have no more questions and will pester you no further.

Again, thanks.

[Bird]

I think you've pretty much settled on the right course of action but it might be worthwhile to clarify/correct a few things...

I chose the cash basis, consistent with my business accounting basis.

Don't you accrue your contributions...deduct them in '06 even if paid in '07?

JanetM:

EZ instructions say for line 10b: Enter the total amount of cash contributions received for this plan year, including contributions due to the trust but not yet received (receivables).

That's the FORM, not the instructions...or at least it's the brief description on the form. But I agree that they're describing accrual basis, and in your case you're not supposed to include the 2005 contributions deposited in 2006...but if you don't then they'll never be reported at all. But I don't think anyone really cares. The reporting does not reconcile (i.e. beginning balance plus net reported changes does not equal ending balance, because you're not supposed to show unrealized capital gains). Since they're not expecting the numbers to reconcile, I don't think you have to be too concerned about it.

[Lori Friedman]

I agree completely with JanetM and Bird. Every taxpayer is accrual-basis with respect to retirement plan contributions. An otherwise cash-basis business entity can deduct an accrued contribution. Individual taxpayers can deduct IRA and self-employment plan contributions that are paid after year-end. If you report accrued contributions on Form 5500, there's consistency and matching between Form 5500 and the filer's income tax return.

[jpod]

Is it clear to everyone (except me) ewhat one is to report for the current year in the case of a discretionary profit sharing contribution?

How is there a "receivable" as of 12/31/06 if the employer has done nothing to justify treating a future contribution as a receivable? More likely than not, the employer won't decide what to contribute until long after the close of the year. Although we may all have a mindset that the employer will contribute the maximum deductible amount, that, no matter how likely, should not create a receivable.

I think you can go strictly cash basis, and report for 2006 the contribution received in 2006 FOR 2005. It seems to me that the worst thing you can do is report something for 2006 as if it was a "receivable," but then not contribute it because you've changed your mind for whatever reason.

[JanetM]

From an income tax angle, if you must make the contribution before you file the 5500. If you don't make it by original due date you have to file extension to later date. Think the IRS view is that if you claim the contribution on your tax return and 5500 but don't make it you have committed tax fraud/evasion. And of course it will be construed as willful fraud and not simple negligence.

[Guest mjb]

I agree with jpod. A contribution for a tax yr is accrued only if there is an obligation to make the contribution as of 12/31. In a descretionary PS plan of a SE person there is no accural until the date the contribution is made which can be as late as 10/15 of the following yr which means a deductible contribution for 06 will accrue in 07 for a cash basis taxpayer. I dont think there is a receiveable until there is a decision to fund the contribution which will occur when the contribution is deposited.

Line 10b requires reporting of all contributions received in the plan yr plus any contributions due (i.e., accrued) as of yr end, e.g., for a MP contribution. A descretionary PS contribution for a SE person is not due at yr end since most SP do not know what their net earnings from SE are as of 12/31 and must wait until a later date to determine the amount of the contribution.

[Guest winterhill]

Thank you; your discussion is hugely helpful (we sole proprietors are probably a nuisance, but we’re very appreciative of this website). You've raised two new issues Tuesday to which I’d like to respond, in hopes it's useful.

1. Agreement between 5500/5500-EZ and personal returns (Bird, Lori Friedman)

To answer Bird's question, my 401(k) contributions are made after year-end, when the profit-sharing component can be calculated from my cash-basis business’s net profit. As a taxpayer, on 1040 line 28 I report QRP contributions designated for that year (yes, “accrued”), reflecting the profit reported on Schedule C. But it's inconsistent with contributions now being reported on my cash-basis QRP filing (begun 2005). My business recordkeeping includes an annual reconciliation statement to reflect the designated year of contributions, which the IRS/DOL never sees. But it's unclear to me whether a reconciliation is adequate (or necessary) to resolve a 1040-5500 inconsistency in the IRS's eyes.

In reporting these post-year-end contributions, it seems as if either reporting basis results in an inconsistency of some kind. A cash-basis 5500's internal math is consistent (contributions agree with net assets, etc.), but the contributions don’t agree with the (accrual-basis) 1040. On the other hand, an accrual-basis 5500 might agree with the 1040, but the numbers within the 5500 don't reconcile.

Which is the lesser evil? The penalties for 5500 problems are ominous (and the desire to avoid raising unnecessary red flags was a factor in my choice of cash basis for QRP reporting). But you apparently feel this kind of internal 5500 inconsistency isn't a significant issue (Bird wrote, “they're not expecting the numbers to reconcile, I don't think you have to be too concerned about it.") Regarding agreement between the 1040 and the 5500, a search of this forum’s threads suggested that it might not be mandatory. (In one thread, for example, Pensions in Paradise wrote: “I recommend filing on an accrual basis. That way the 5500 will reflect the same numbers as your personal tax return. Just my personal preference.”) But you've raised the issue, so I'd be grateful for clarification: how important (or essential) is agreement between contribution numbers on the 1040 and 5500? Does it require accrual-basis QRP reporting or can it be accomplished via reconciliation?

2. Eligibility of post-year-end discretionary contributions for treatment as accrued obligations (jpod, mjb, JanetM)

Thank you for raising this question. (It was another concern that contributed to my choice of cash basis. IF it's true these discretionary contributions can't be accrued, then using accrual-basis reporting of contributions could become problematic.) You responses took care to emphasize avoiding any possibility of fraud due to a reported contribution not ultimately being made (thank you, point taken). Your solutions, as I understood them, ranged from using strict cash-basis QRP reporting to making sure post-year-end contributions have been made before accruing them. I can see the merits of each approach --but they seem mutually exclusive, based on very different assumptions (particularly about accounting basis). So I'd be grateful for any clarification or additional thoughts on this subject.

Please feel free to respond to parts, or none, of the above.

Again, thank you very much.

[Bird]

winterhill, you are to be commended for trying to do this right and I truly respect your obsessing over it, really. But the reality is that the instructions are contradictory and unclear, and it doesn't make a &$*#ing bit of difference what you do. No one is checking your work. I find it easiest to include accrued contributions in the ending balances and to show total contributions "for" the year on the contributions line, even if contributed after the end of the year, as the form says. So that's what I do. Do what works for you and don't worry about it. I think the IRS assigned the 5500-EZ form to some kid out of school, probably a film major who couldn't get another job; if you think about this for very long you realize that this information is of no use whatsoever and they just feel like they have to collect data, even if they're not doing anything with it.

Having said that, to the extent it matters (not at all) I disagree that there should be a difference between discretionary and required contribution reporting on this particular form. It just makes no sense to me.

[jpod]

Without specifically commenting on Bird's thoughts, if you report a contribution made post-year-end on the theory that it was "accrued," or it became a "receivable," make sure it is included as part of the year-end assets (even though it wasn't?!?).

[Lori Friedman]

How is there a "receivable" as of 12/31/06 if the employer has done nothing to justify treating a future contribution as a receivable? More likely than not, the employer won't decide what to contribute until long after the close of the year. Although we may all have a mindset that the employer will contribute the maximum deductible amount, that, no matter how likely, should not create a receivable.

First, a contribution made after year-end, but before the tax return's due date (including extensions), is considered to have been made on the last day of the tax year [i.R.C. Sec. 404(a)(6)]. Even though the contribution is made during the following year, and even though the amount may not be determined until long after the end of the tax year, federal law deems the amount to be an accrued contribution.

Second, when a taxpayer files its return and claims a deduction for a contribution, it makes an irrevocable election to deposit the contribution [Rev. Rul. 76-28; Rev. Rul. 76-77]. The taxpayer can't amend its tax return to "take back" the contribution.

The employer has a liability for its accrued contribution. Likewise, the plan has an asset -- an amount receivable from the employer.

[jpod]

Lori:

I think it's a bit of a stretch to say that the "federal law deems an amount to be an accrued contribution." What the federal tax law does is create an exception to the mandatory "cash basis" rule under Section 404 if the contribution is made by the due date of the income tax return.

Another point, as mjb already mentioned, is that the 5500 can be filed long before the employer decides how much to contribute to a discretionary profit sharing plan, let alone actually deposits the contribution. Most of us expect that the reverse will occur, but that's not required.

Finally, there is no receivable as of 12/31 (or other year-end) for a discretionary profit sharing contribution, at least not under any reasonable interpretation of the word "receivable."

[Guest Dell]

First, it's not a big deal. My view is that the 5500 should record the contribution for the current year that is going to be funded by the deadline, even if well after year end.

Ipod is also correct from an accounting sense regarding what is a receivable. I just don't think the 5500 is necessarily based on GAAP in this situation. FWIW, in the case of a DB Plan additional contribution decided upon after the financial statements and 5500 are already filed, the additional contribution for the year is considered a subsequent event. The 5500 is to be amended but the financials are not restated. The opinion is dual-dated for a new note disclosure reconciling the amended 5500 to the financials. Effectively it is not a receivable for FS purposes, but it is picked up on the 5500. I know this is not the same as the thread topic, just pointing out how it is handled in this situation.

[jpod]

Let's look at the big picture. The 5500 is designed to fulfill the ERISA "reporting and disclosure" requirements, as well as the IRS "information" reporting requirements. How is it consitent with those goals to report a contribution on the 5500 where the contribution for the year has not been made yet and there is no legal obligation to make a contribution for the year? Many of you seem to be saying, at least implicitly that you cannot or should not file a 5500 until you've made the contribution for the previous year, but if that's true please tell me where that is written because it's the first I've heard of it.

[WDIK]

Many of you seem to be saying, at least implicitly that you cannot or should not file a 5500 until you've made the contribution for the previous year, but if that's true please tell me where that is written because it's the first I've heard of it.

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[Guest Dell]

My previous post was to point out that the 5500 can report a receivable for a discretionary contribution not decided upon until after year-end, in contrast to the GAAP treatment, at least as far as that guidance from the AICPA goes. This assumes accrual basis.

I will agree with jpod regarding a truly cash basis plan. The instructions for a 5500 say noncash basis plans record the receivable, and that "plans using the accrual basis of accounting should not include contributions designated for years before the 2006 plan year on line 2a." It only makes sense then, if you are cash basis, you would not record a receivable and would include all contributions made during the year, not just FOR the year. I would treat the EZ the same for these purposes.

I still think most cash basis plans still file on a modified basis, showing the receivable and reporting contributions FOR the year, not contributions received during the year. Especially when subject to minimum funding standards.

On the cash basis you can do pretty much whatever you want, the important thing is to be consistent.

[Belgarath]

FWIW...

I suspect the whole issue may be theory vs reality. For those that believe a cash basis EZ filer for a profit sharing plan must make the contribution prior to filing the EZ, can I ask this: Have you ever actually seen a case where it has been kicked back, had problems on plan audit, etc., for this reason alone? Any penalties levied on a filing for this reason?

I will say that I have seen, literally, thousands of EZ's filed for PS plans, on a cash basis, and filed prior to the time the full PS contribution has been made. Have never once seen a problem associated with this method.

Since many clients do not actually make the contribution until the last possible minute, I'd certainly say the chances of filing the EZ late (and adverse consequences of that late filing) surely outweigh the "risks" associated with a cash basis filing prior to the date the contribution is made.

[jpod]

I agree with everyone who has said that the issue is more theoretical than real. However, the point I am stuck on is that in reporting year-end assets, whether its the EZ or a Schedule H or a Schedule I, it is simply not right to include a discretionary profit sharing contribution which was not been made before the end of the year. It wasn't made, and it is not a "receivable" under any reasonable defintion of that word. So, if you can't report it as a plan asset as of year end, it seems illogical to me to report it as a contribution for the year.

[WDIK]

Although the following from the 2002 Annual Conference IRS Questions and Answers does not directly address the 5500 reporting issue, it may be of interest to note that a receivable discretionary profit sharing contribution certainly is an asset as of the end of the prior year for some purposes.

p 49. Receivable Contribution and Top Heavy Determination? Is a discretionary profit sharing contribution for the prior plan year that is deposited after the end of the prior plan year included in the top heavy determination for the current plan year? Let’s say we have a calendar year plan, effective several years ago. We are determining the plan's top heavy percentage for the 2002 plan year. The determination date is therefore 12/31/01. The employer makes a contribution in February, 2002, which is allocated and deducted as of 12/31/01. There is a question as to whether this contribution is included in the top heavy determination for the 2002 plan year. The question relates to Q&A T-24 of the 416 regulations, which says that if a plan is not subject to 412, then the account balances are not “adjusted” to reflect a contribution made after the determination date.

A. The key phrase here is “account balance”. The participants’ account balances, as of (say) 12/31/01, include the profit sharing contribution that is allocated and deducted for the 12/31/01 plan year end. So the guidance regarding “adjustments” does not apply to the receivable profit sharing contribution; it is already part of the participants’ account balances.

The following is my analysis:

The question as to what contributions are considered due on the determination date is determined under §1.416-1, Q&A T-24, which says that it “is generally the amount of any contributions actually made after the valuation date but on or before the determination date”. It then goes on to say that any amounts due under §412 are considered due, even if not made by the determination date. One could take the position that this is a exclusive statement; in other words, if a contribution is NOT due under 412 and is made after the determination date, it is not considered 'due'. However, the answer to the question (T-24), “How is the present value of an accrued benefit determined in a defined contribution plan” is answered, “the sum of (a) the account balance as of the most recent valuation date occurring within a 12-month period ending on the determination date, and (b) an adjustment for contributions...” The term, "the account balance" includes contributions credited to the account of a participant, it does NOT mean only the contributions actually made that have been credited. For example, if a 100% vested participant terminated after the determination date but before the contribution was actually made, the distribution would include that contribution, even though it had not yet been made to the plan. This is because the account balance, as of the last day of the plan year, includes the contribution. So, when the regulation addresses adjusting the account balance for contributions made after the determination date, we must start with the account balance, and then apply the adjustments. Since the account balance includes the receivable profit sharing contribution, the adjustment does not refer to the receivable. The reference to §412 in §1.416-1 is with regard to a waived funding deficiency that is not considered part a the participants' “account balance”, as the term is defined. Q&A T-24 refers to a DC plan with a waived funding deficiency that is being amortized. Such a plan must maintain an “adjusted account balance” (reflecting the amount of the contribution that has not been deposited) which must be maintained until the actual account balance increases to the point where it equals the “adjusted account balance”. It is to this (unadjusted) account balance that the (waived) contribution must be added, since the amortized contribution only becomes a part of the actual account balance as it is paid to the plan. The requirement therefore has the effect of determining top heavy status as though the contribution required under 412 had actually been made. In other words, the “account balance” would not include the waived minimum funding contribution, so an adjustment is required.

We accept this analysis.

[Guest mjb]

WDIK: Since a discretionary PS plan is not subject to 412, are the participants' account balances credited with the contribution if the employer does not make a TH contribution and takes no deduction for the plan yr by the date for filing the tax return?

[WDIK]

mjb: Are you asking a question to which you already know the answer?