Sole Prop becomes LLC

[richard]

An individual has been running a business as a sole prop for several years (John Smith, A Sole Proprietorship), and in November 1999, converts it to an LLC (XYZ, LLC), using a tax free asset conversion.

He wants to establish a pension plan effective 1/1/99. (The tax years of the business and LLC are both 12/31).

The plan is being established with both entities (John Smith, A Sole Proprietorship and XYZ, LLC) being defined as "employers"

For 1999, the sole prop will take most of the deduction since most of the earnings was run through the sole prop.

However, by the time the majority of the contribution is made (in early 2000), the sole prop will cease to exist and its assets will have been transferred to the LLC.

Can the LLC make the contribution in early 2000, and have the sole prop take the deduction for it?

Am I worrying too much for nothing? Is there a real issue? What other ideas or issues are there?

Thanks.

[Guest L TURNER]

The sole proprietorship(SP)claims the deduction whether the LLC makes the deposit or the SP. The SP is one and the same with the individual, so if the individual makes the contribution, the deduction will be taken on the 1040. If the liability for making the deposit to the plan is transferred to the LLC, then the LLC could make the deposit and extenquish the liability transferred to it (no deduction at the LLC level of course, still at the 1040). Or, the LLC could make the deposit even though the liability was not transferred to the LLC and the payment to the plan would be treated as a (potentially) non-taxable distribution to the LLC member(s), or partners. Any way, the deduction will reside with the SP (1040). I don't think you have a problem here. Good luck!

[richard]

Thanks, L. Turner. Life, sometimes, is simple.

Now for a followup. Same situation. Let's focus on the trustee issue.

The client would like the employer to be the trustee (rather than the individual owner). So far, pretty normal.

By now, the client has already formed his corporation (XYZ LLC), and therefore the documents will indicate that this corporation is the trustee. However, the plan will be adopted shortly and be effective retroactively to 1/1/99; technically, XYZ LLC didn't exist prior to late 1999. So, technically, shouldn't John Smith, A Sole Proprietorship also be a trustee, at least for the period prior to the formation of XYZ LLC?

Or am I worrying about nothing --- again?

Thanks.

[davef]

It has always been my understanding that only corporations with trust powers and individuals can serve as trustees. So, unless the LLC has trust powers, I don't think it can serve as trustee of the plan.

[Guest L TURNER]

I think you are worrying about a problem that does not exist. There is no problem naming the LLC as the trustee on a plan newly created and retroactive to the beginning of the year. I do not know how often this occurs, but I'm certain individual trustees have been named for new plans who were not even employed by the sponsor on the effective date of the trust. Same analogy here; you are allowed to create a plan on the last day of the plan year retroactive to the first day of the year. December 31 is the last day of your proprietorship, not the day the business converted to an LLC. So, no problem in my opinion.

[davef]

There is a somewhat obscure regulation (1.401-12©) which may have an impact on this situation. Basically, what it says is that a plan covering an owner-employee must be have a bank trustee (unless certain exceptions apply). Even though the reg is fairly old, from what I can tell, it has not been superceded.

Based on this, there should at least be a bank trustee during the part of the year he was a sole proprietor. This may be an issue that the IRS doesn't look too closely at, but I thought I'd raise it for consideration.