Ps or Sep plan for 1 year

[Guest cascigm]

For a one ee company, is it inappropriate to install a plan for 1 year and take deduction, knowing that in yr 2 the plan will terminate? ie. company will terminate.

[Guest Malou]

Generally, it would be better to establish a SEP in this situation rather than a profit sharing plan. As long as the business is actually in existance during the year for the plan, there should be no problem with ceasing contributions to the SEP in future years due to the termination of the business.

[Dave Baker]

Under old but still applicable IRS regs, a tax-qualified retirement plan must be designed to be "permanent," as distinguished from being set up as a short-term tax shelter for one or a couple of unusually good years. (Section 1.401 something or other.)

For example, I think the IRS audit guidelines for terminating plans ask the examiner to see whether the plan has been in effect for at least 10 years, and if not to see whether there is any good business reason for the termination.

There is no such rule for a SEP (governed by a different Code section -- 408, not 401), so that's definitely the way to go in this situation, I think.

[richard]

Does the company "know" it will terminate existance in year 2? While a plan must be designed to be permanent, the plan can terminate in a relatively short number of years (even, believe it or not, one year) due to unforeseen events (e.g., legislative changes making the plan inappropriate or unaffordable, business decline, merger or acquisition, etc.).

I haven't seen any specific statutory rules (though I'd be interested in them if anyone has cites). What I generally tell clients, beyond what I said in the previous paragraph, is that as a practical matter 5 years is generally OK, 1 year is generally bad, anything in between is a gray area, depending on the situation, the IRS mood, etc.

Can we expand this question to ask if anyone knows of any specific situations where the IRS actually took action (e.g., disqualification or other action) on a plan that was in existance for too short a time period.

(By the way, if the company were considering a profit sharing plan, I agree with Malou that a SEP would in general be better.)