Partners and deferrals

[jkharvey]

I need clarification on this. Partners can make elective deferrals on draws during the year (guaranteed payment or not a guaranteed payment)? If the partners decide to terminate the plan on let's say 11/1 would the partner then have no income for plan purposes since his income is determined on 12/31?

[Blinky the 3-eyed Fish]

That's an argument you could make, although I wouldn't. I propose the earned income is earned ratably throughout the year.

[Bird]

If backed into a corner I think I would argue that the income is earned ratably over the year, but I'd rather not. I think I'd figure out a way to terminate the plan on 12/31 and avoid that issue. Freeze it on 11/1 or whatever.

[Gary Lesser]

In general, a partner's compensation is deemed currently available on the last day of the partnership taxable year and a sole proprietor's compensation is deemed currently available on the last day of the individual's taxable year.

1.401(k)-1(a)(6)

(6) Rules applicable to cash or deferred arrangements of self-employed individuals

(i) Application of general rules.

Generally, a partnership or sole proprietorship is permitted to maintain a cash or deferred arrangement, and individual partners or owners are permitted to make cash or deferred elections with respect to compensation attributable to services rendered to the entity, under the same rules that apply to other cash or deferred arrangements. For example, any contributions made on behalf of an individual partner or owner pursuant to a cash or deferred arrangement of a partnership or sole proprietorship are elective contributions unless they are designated or treated as after-tax employee contributions. In the case of a partnership, a cash or deferred arrangement includes any arrangement that directly or indirectly permits individual partners to vary the amount of contributions made on their behalf. Consistent with §1.402(a)- 1(d), the elective contributions under such an arrangement are includible in income and are not deductible under section 404(a) unless the arrangement is a qualified cash or deferred arrangement (i.e., the requirements of section 401(k) and this section are satisfied). Also, even if the arrangement is a qualified cash or deferred arrangement, the elective contributions are includible in gross income and are not deductible under section 404(a) to the extent they exceed the applicable limit under section 402(g). See also §1.401(a)-30.

(ii) Treatment of matching contributions made on behalf of self-employed individuals.

Under section 402(g)(8), matching contributions made on behalf of a self-employed individual are not treated as elective contributions made pursuant to a cash or deferred election, without regard to whether such matching contributions indirectly permit individual partners to vary the amount of contributions made on their behalf.

(iii) Timing of self-employed individual's cash or deferred election.

For purposes of paragraph (a)(3)(iv) of this section, a partner's compensation is deemed currently available on the last day of the partnership taxable year and a sole proprietor's compensation is deemed currently available on the last day of the individual's taxable year. Accordingly, a self-employed individual may not make a cash or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of that year. See §1.401(k)-2(a)(4)(ii) for the rules regarding when these contributions are treated as allocated.

(iv) Special rule for certain payments to self-employed individuals.

For purposes of sections 401(k) and 401(m), the earned income of a self-employed individual for a taxable year constitutes payment for services during that year. Thus, for example, if a partnership provides for cash advance payments during the taxable year to be made to a partner based on the value of the partner's services prior to the date of payment (and which do not exceed a reasonable estimate of the partner's earned income for the taxable year), a contribution of a portion of these payments to a profit sharing plan in accordance with an election to defer the portion of the advance payments does not fail to be made pursuant to a cash or deferred election within the meaning of paragraph (a)(3)(iii) of this section merely because the contribution is made before the amount of the partner's earned income is finally determined and reported. However, see §1.401(k)-2(a)(4)(ii) for rules on when earned income is treated as received.

Treas. Reg. Section 1.401(k)-2(a)(4)--

(4) Elective contributions taken into account under the ADP test

(i) General rule.

An elective contribution is taken into account in determining the ADR for an eligible employee for a plan year or applicable year only if each of the following requirements is satisfied --

(A) The elective contribution is allocated to the eligible employee's account under the plan as of a date within that year. For purposes of this rule, an elective contribution is considered allocated as of a date within a year only if --

(1) The allocation is not contingent on the employee's participation in the plan or performance of services on any date subsequent to that date; and

(2) The elective contribution is actually paid to the trust no later than the end of the 12-month period immediately following the year to which the contribution relates.

(B) The elective contribution relates to compensation that either --

(1) Would have been received by the employee in the year but for the employee's election to defer under the arrangement; or

(2) Is attributable to services performed by the employee in the year and, but for the employee's election to defer, would have been received by the employee within 2 1/2 months after the close of the year, but only if the plan provides for elective contributions that relate to compensation that would have been received after the close of a year to be allocated to such prior year rather than the year in which the compensation would have been received.

(ii) Elective contributions for partners and self-employed individuals.

For purposes of this paragraph (a)(4), a partner's distributive share of partnership income is treated as received on the last day of the partnership taxable year and a sole proprietor's compensation is treated as received on the last day of the individual's taxable year. Thus, an elective contribution made on behalf of a partner or sole proprietor is treated as allocated to the partner's account for the plan year that includes the last day of the partnership taxable year, provided the requirements of paragraph (a)(4)(i) of this section are met.

[pmacduff]

ok - help!

I have a partnership with 3 partners, 50%, 25% and 25%. Safe harbor non-elective 401(k) Plan. NHCE Employees' 3% goes in every payroll with their 401(k) deferrals.

The firm's HR person left and everyone involved is not sure what partner income figures she provided us as TPA in the past. I said "no problem, let me talk to the Accountant" which I did.

For 2008 the 50% partner put $20,500 into his 401(k) account (he is over 50). Neither of the other 2 partners contributed any 401(k). Accountant tells me that the bottom line on the partnership is $0.00 but that the 50% partner had $28,000 that he "took out" of the partnership and added on with his Sch C income (that is over $500,000). If the partnership income is "$0.00" doesn't that mean that none of the partner's can make ANY 401(k) contributions? The one partner's $500,000 Sch C does not impact the partnership....or does it?

any assistance appreciated!

[K2retire]

If the partnership income was zero, where did the other half million come from?

[jpod]

It could be they are just running everything onto each partner's Schedule C (to "facilitate" deduction of expenses). Obviously, this would be wrong. Need to see the partnership's Form 1065 and all K-1s. Need to understand the true legal relationship between the so-called partners. Maybe there is a partnership for certain purposes, but also separate sole proprietorships. Could be an affiliated service group with 1 plan for all members and their collective employees.

[pmacduff]

the other $500,000 was referred to by the Accountant as that partner's income as a "sole proprietor". Accountant does the Partnership return and the Schedule C for only the one (50%) partner.

The other two partners have a different Accountant doing those Schedule Cs for them as "sole proprietors" as well. No employees other than the ones under the Partnership 401(k). The plan covers all of the Partnership employees and consists of the 401(k) and safe harbor 3% non-elective only.

The Accountant is going to send me the 1065 and K-1 info.

If the partnership net income truly is $0 are the partners prohibited from elective deferrals under the partnership Plan if there is no affiliated service group?

[Bird]

One possibility that would make this work is if the sole proprietors, or at least the one who made contributions, was an adopting employer of the plan, either directly, by virtue of an adopting document, or indirectly, by virtue of a provision that automatically includes members of a controlled group or affiliated service group. But I guess if you've been doing the admin for a while you would know if that situation existed.

jpod's thought that they are running expenses through Sch Cs as a convenience is probably correct. It's such an incorrect way to report things that you might actually be able to take the position that you are going to count the sole prop income for the plan because it really and truly is partnership income. I don't really know enough about the sole prop income (does it all come from the partnership or is it really other income?) and am just thinking out loud.

[K2retire]

No indication of the type of business, but I suspect there may be an affiliated service group or controlled group. The simple solution is for the sole proprietorship to be a participating employer. But I don't think you can make that happen retroactively.