Can partners reverse deferrals after year end?

[Spencer]

I have a new,small client who was Top Heavy for 2009. The owners deferrred $600 and $1800 in 2009 before being notified that they would fail ADP testing. The Top Heavy min is for 2009 $4000. They want to know if they can reverse their 2009 deferrals so that no TH min would be required. They are an LLC taxed as a partnership and they have not filed for 2009. They think they can just "reclassify" the deferrals.

Obviously, this is not a mistake of fact. They just want to avoid the TH min contribution. Can they do this?

[Guest Sieve]

According to the 401(k) regs relating to self-employeed individuals, a deferral election resulting in deferrals from "draws" against ultimate profits is treated as proper even though all self-employment income is treated as received on the last day of the year. (Treas. Reg. Sections 1.401(k)-1(a)(6)(iv) & -2(a)(4)(ii).) Of course, the deferral still must be made pursuant to a proper election.

So, what they are requesting is not possible any more than if they were shareholders of a corporation requesting to change the same deferrals.

[Spencer]

Thanks.

I also talked to CPA who advised that IF they did this, they would have to amend their W-2's and personal tax returns (if filed) and it would be obvious that they just trying to avoid the TH min. We have advised the client against this for a variety of reasons.

[austin3515]

Plus if it was on a platform and the money was posted as 401k, I'd suggest you'd have a pretty hard time suggesting it was anything but 401k. And Sieve's point is also a good one, which I think he was suggesting that if on payroll reports the money says it's 401k from the draw, you'd have a similar issue.

Be careful since the participants may have already accrued a right to the THM, and any "funny stuff" will be a cut-back (or worse!).

[BG5150]

And what would they re-classify it as? Any contribution for them would be considered an allocation for TH purposes.

[Spencer]

Now the financial advisor wants me to contact the financial instition to have the deferrals made in Jan and Feb 2009 reversed. Not reclassified, reversed. AND the Top Heavy was deposited by the client on 06/07/10. They want that reversed too. I have advised that this would be very obvious that the intent was to avoid the TH minimum.

The plan was TH at the end of 2008. The owners (key ees) deferred in 2009. The participants did accrue the right to the TH minimum already. Anything we do to try to avoid the TH minimum would be unethical.

Please help list the reasons this is wrong so I can convince both the client and the financial adivsor (and my boss) that we should have no part of this.

reversion of assets

no distributable event

violation of anti-cutback rule

not following the deferral elections

breach of fiduciary duty

[K2retire]

The client may not care, but you and the boss should be discussing the potential liability to your firm for facilitating tax fraud. I doubt that your boss is willing to risk jail time for this client, but if he/she is, you might want to polish up your resume.

[Belgarath]

Is this really tax fraud? I'm no attorney, but it would seem that since the tax deduction will actually be REDUCED under the scenario contemplated, that it isn't tax fraud? It's lots of other bad things, certainly. Any attorneys out there who know the answer to this?

[Guest Sieve]

How about a violation of ERISA Section 403©(1) & 403©(2)(1)?: ". . . the assets of a plan shall not inure to the beneift of any employer [unless] such contribution or payment is made by an employer to a plan . . . by a mistake of fact . . ." "We didn't intend it to happen" is not a mistake of fact. Nor is "we didn't realize the plan was top heavy".

Also, IRC Section 401(a)(2) requires, as a condition of tax-qualification, that the plan provide that "it is impossible, at any time prior to the satisfaction of all liabilities . . . for any part of the corpus or income to be . . . used for, or diverted to, purposes other than for the exclusive purposes of . . . employees . . . " So, the plan provisions will have been violated, and the plan will be disqualified.

[austin3515]

I think a case could be made for embezzlement, and that's a crime, isn't it? I suppose there are no good semaritin laws forcing you to report them, but then again, I think you should pay someone $350 an hour to advise you on that (assuming they're worth it!)

[Spencer]

It was a bit frustrating having to prove I was right, but thanks to input from here and ASPPA members, I had no trouble convincing my boss, the client and the broker that this could not be done.

Thank you all!