Failed coverage test for numerous years

[Guest SWH]

Client referred from their new accountant due to potential problems with retirement plans. After speaking with client and their new accountant, discovered that client was part of controlled group. Previous accounant only had them doing contributions on the company that had the owner as the only employee. This has been going on for almost 8 years!

Need to to a VFCP submission to get plan correction done to correct for failed coverage tests and get plan in compliance. My big question here is How can we fix this? What we want to do is return the contributions (plus earnings) to client and make them pick up as taxable. Going back and giving 25% contributions to the employees is NOT an option. It would bankrupt the company. Owner only put in at most $12k a year.

Anybody come across this before?

[jpod]

1. Presumably you thought of this already, but I'll ask: other entity did not have a plan?

2. Depending upon the amount at stake, before taking any action your client may wish to put prior accountant and accountant's insurance carrier on notice and see if they would like to become involved in the process of "fixing" this plan. (Also put on notice any other professional who provided bad advice and its insurance carrier). If there are damages to your client they could be liable.

[Guest fender5150]

Anybody come across this before?

I know a guy...

who told me this kind of thing happens all the time in the small business community. If misery loves company, you have plenty of company.

It's (not) funny; but the client could have legally deferred the 12m per with no significant expense if she/he had consulted a professional to begin with. I'm assuming 12m total was deferred: Not 12m whs plus 12m contributions.

If you reclass the contributions as non-taxable; is the CPA going to do 8 years worth of amended returns free of charge? Otherwise, the filing fees and penalties make this an expensive option as well. (8 years of amended company tax returns, personal returns, and 5500s).

Maybe the CPA will kick in some money to avoid this work.

[ak2ary]

Depending on the number of employees, it may be cheaper to just let the plan be disqualified

[Guest SWH]

The other entity did not have a plan.

The other entity paid the main entity a management fee and the owner took his pay from that company -- the one with only him as an employee.

This was a strict PS plan so all money came from employer contributions. Before the company had employees, there was only one company. Once they knew that they were going to get employees, a new company was set up.

If disqualification were the route that we went, would they disqualify just for the past 8 years or is there a chance that they would disqualify the entire plan and make all $12M taxable, etc to owner?

[K2retire]

The other entity did not have a plan.

The other entity paid the main entity a management fee and the owner took his pay from that company -- the one with only him as an employee.

This was a strict PS plan so all money came from employer contributions. Before the company had employees, there was only one company. Once they knew that they were going to get employees, a new company was set up.

If disqualification were the route that we went, would they disqualify just for the past 8 years or is there a chance that they would disqualify the entire plan and make all $12M taxable, etc to owner?

The situation that you describe sounds like the exact reason that the controlled group rules were established in the first place. The attorney who helped set up the other company should have warned about such things.

[Peter Gulia]

The scenario described above taps into my long-time professional and academic curiosity about how much responsibility a professional has (or should have) for a question that his or her client didn’t ask.

For example, imagine that a business owner called her generalist business lawyer and instructed him to form a new corporation. The lawyer collected enough information to do a competent job of writing the incorporation papers. The client said nothing about why she was forming a new corporation. Should a lawyer in those circumstances be expected to anticipate a problem of the kind described in the originating post?

Likewise, imagine that an accountant has not been asked to consider whether a retirement plan is a qualified plan. What (if anything) might trigger a duty to consider whether a plan is disqualified in form or operation? And if some duty is triggered, what does the accountant do? And who pays for the accountant’s time on a topic that the client didn’t ask the client to get into?

[K2retire]

All good questions Peter. But if the expert (attorney or accountant) doesn't at least ask questions about these ramifications, how can the client be reasonably expected to know that there might be other issues to consider?

When I taught pension law to paralegal students, none of whom expected to work in the field, I pointed out to them that there were 3 instances where the information I was teaching would be useful to them: 1. they could reasonably expect to be a plan participant at some point; 2. if they ever worked in domestic relations they needed to be aware of QDROs; and 3. if they worked in corporate law (particularly mergers and acquisitions) retirement plans needed to be part of their due diligence for the client.

[PensionPro]

Every TPA firm that I have known has this question about related employers as part of their initial questionnaire to prospective clients, along with questions about leased employees, prior plans, etc. If these questions were not asked, then the design process was faulty, and the consultant not the client is the guilty party. In my opinion.

Anyway, going back to the original poster: I am assuming a VCP filing is intended, not a VFCP filing. I would think the IRS is more agreeable to reallocation of the contributions, rather than withdrawal or distribution.

[Guest Sieve]

George --

To follow-up on your comments . . .

Don't know that an attorney preparing incorporation or other organizational papers could conceivably ask all the questions necessary--or even know what those questions were--to make sure that something, somhow isn't remiss behind the scenes.

The controlled group question, however, should be asked (and then answered by the client) as part of the info collected annually by the accountant/TPA for completing the Form 5500, since there is a Code for it in Item 8 (Code 3H). And the client/plan sponsor signs the Form 5500 under penalty of perjury (which the preparer always should remind the client when the Form is sent fr signature). Seems to me that answers the practical question of who should ask the question and who should be responsible if it's not answered properly. And, when taking a plan on conversion, a TPA/accountant/lawyer certainly should review a few Forms 5500 to see what kind of animal there is.

[BG5150]

Does a controlled group status affect anything else in business other than whether retirement plans need to be combined for certain reasons?

[Guest Sieve]

I am sure that there are other contrroleld group definitions and comparable rules for other reasons, but an attorney simply setting up a corp or LLC is not able to address and give "warnings" for all potential business transactions at that point. If this is a continuing client for the attorney, then I would agree that the attorney has an obligation to issue appropriate "warnings".

For genereal tax purposes (consolidated returns), the IRC controlled group rules have recently been changed from 80/50 to 50/50--but the old 80/50 rule remains for pension purposes. I often have to speak directly with accountants of new plan sponsors who sign on with my TPA client in order to determine if there is an 80/50 controlled group, or an ASG, so that the TPA can properly complete the adoption agreement. (The same question ought to be asked, frankly, if an attorney prepares an individually-designed or volume submitter document--but, of course, that can change, and thus the need to ask the question annually for the Form 5500.) With smaller employers, there hardly is ever any attorney input or contact or concern re: the 401(k) documents prepared by the TPA, because few attorneys dare to wade into that morass.

In my exoperience, if a TPA has close contact with an employer then it probably will learn when there has been a corporate merger or acquisition so that changes can be made to the adoption agreement.