Deemed CODA

[12AX7]

I'm sure this has been discussed before. Two partners, no other employees. Each partner would like to control their profit sharing contribution to the plan. If the partnership prepares a resolution to the effect that governs the allocation, would this avoid a possible deemed CODA?

[Bird]

I don't think you can completely close the door on that argument in a self-employed scenario, but documenting the entity's separate decision-making represents best practices.

[12AX7]

I'm not sure how the decision making could be separated from either partner's discretion in the matter. It was brought to my attention that Jim Holland had comments about this issue at an ASPPA conference.

[Bird]

Therein lies the rub; it is of course a cash or deferred arrangement if each one is independently deciding how much to contribute and has the ultimate power to make that decision. But, it is at least technically a partnership decision, and you document it as such. I'm not totally cavalier about it; I have a partnership with 12 or so partners and I make them take the same amounts...because they're used to it, and because they have enough trouble deciding on one number for the group. let alone letting each one make a decision, and because I don't think it looks good (from the deemed CODA standpoint) to have 12 different contributions. Maybe that's not consistent...

[Jim Chad]

Would a triple stacked match solve this problem?

[12AX7]

That's a good way to give more to the only partner that contributes for a year. My concern is where the contributing partner decides that he wants to put in only $15,000 for the year. I would have to split that amount between 401 (k) and the other fixed components of the stacked match, while taking into consideration the circular calculation. Is there a spreadsheet around that does this?

[12AX7]

Well, it turns out the prospective client is an S-Corp (I was given bad info by the client) and the Deemed CODA would become perhaps a nonexistent issue. I will propose a plan that creates an allocation group for each eligible participant. Our Volume Submitter plan has that language. Thanks Jim and Bird for the input.

[Dougsbpc]

I don't know if anyone wants to continue discussing this, but what if you had a partnership of corporations? Suppose you had 10 partners and each 10% partner was a corporation covering one individual? In this scenario, I would think the partnership would sponsor the profit sharing plan and each corporation could adopt the plan as a participating employer. Each corporation should then be able to determine its own contribution for its employees without the plan being considered a CODA.

[J Simmons]

I don't know if anyone wants to continue discussing this, but what if you had a partnership of corporations? Suppose you had 10 partners and each 10% partner was a corporation covering one individual? In this scenario, I would think the partnership would sponsor the profit sharing plan and each corporation could adopt the plan as a participating employer. Each corporation should then be able to determine its own contribution for its employees without the plan being considered a CODA.

I agree, Doug. Because in your example, it is the separate corporations that are each making the decision, and each of the 10 partners owns 100% of his corporation.

In a situation like 12AX7 posits where there are more than one S shareholder/employees, the opportunity to blow it and have a nonqualified CODA yet exists. Granted, corporations generally have a more formal and structured decision making process than partnerships. However, the decisions are a bit metaphysical as Bird's posts demonstrate. What makes the decision as to the contributions made by the ER (corporation or partnership) one made by the ER rather than the EE who is an owner and part of the ER's decision making body? As Bird points out, best practices includes documenting the decision as one by the ER (partners, as a body, or board of directors of a corporation), and not have anything in writing indicating that the others were simply deferring to the individual owner/EE. Also, there should not be corresponding deductions to the profit or distribution shares of the individual from the ER.

[12AX7]

Also, there should not be corresponding deductions to the profit or distribution shares of the individual from the ER.

I'm jumping back into this a little late. Could you please explain how this works on the accounting side of things?

[J Simmons]

Also, there should not be corresponding deductions to the profit or distribution shares of the individual from the ER.

I'm jumping back into this a little late. Could you please explain how this works on the accounting side of things?

Well, this is the fly in the ointment. Let's make an easy example. A and B each own 50% of P, and distributions of P's profits follows these ownership proportions. That's how P's partnership agreement reads.

P has $200,000 net profits for the year, or $100,000 each. A max'es out at $16,500 her 402g limit (she's under 50 as of 12/31) into P's 401k plan. So A will have $83,500 distributable to her, while B chose no 401k elective deferrals and yet has $100,000 distributable to him.

Suppose further that A would like another $20,000 of pre-tax benefit accrual into the profit sharing portion of the 401k plan. There are no other employees, and B is happy to oblige A so long as P's accountant will allocate all $20,000 of the cost as a hit against A's $83,500 share, and none against B's $100,000 share.

If P's accountant okays that allocation (despite the partnership agreement, or per an addendum to it signed by both A and B), do you think that the IRS would find that makes the situation look like a nonqualified CODA exceeding the 402g limits? That is, would this allocation that lines all of the cost up against only A's $83,500 share suggest that there has really be a $36,500 401k elective deferral? rather than a $16,500 401k elective deferral and a $20,000 "profit sharing" contribution?

[Tom Poje]

or, as the IRS officials indicated at one of the ASPPA Q and A sessions in regards as to whether a CODA has been created.

"We will know abuse when we see it"

[J Simmons]

or, as the IRS officials indicated at one of the ASPPA Q and A sessions in regards as to whether a CODA has been created.

"We will know abuse when we see it"

Yeah, kind of like Justice Potter Stewart describing obscenity, "I know it when I see it".

[12AX7]

I understand. Now wouldn't the Sole Prop have the same issue since all the deduction (for the Sole Prop) would be taken on the 1040?

[J Simmons]

I understand. Now wouldn't the Sole Prop have the same issue since all the deduction (for the Sole Prop) would be taken on the 1040?

Not really. You see, in the example of two partners, A and B, assessing all of the extra $20,000 to A's share of P's net profits belies the assertion that A+B, jointly as partners on behalf of P (the ER), made the decision. Rather, the fact all $20,000 is assessed against A's share only points up that B was not really involved in the decision, but A alone was.

With a sole proprietorship, how does one make the decision for the ER? A alone makes that decision because she has no partners or other owners. How then does A make an ER decision rather than an EE decision, when A alone makes each type of decision? Here, A wears two hats, alternatively. One hat is as an ER, the other as an EE. Documentation is important. It would be detrimental for A to use a 401k elective deferral election form for more than the $16,500. A should instead sign a declaration, as sole proprietor of the ER, for the additional $20,000 contribution.

Is it a fiction with respect to a sole proprietor doing so? Certainly, but it is one the IRS allows. Otherwise, it would have to limit sole proprietors to $16,500 per year, while partners and shareholder/EEs could do $49,000. To avoid this inequitable result, the IRS honors the fiction.

However, the fiction is not necessary to override the inequity and does not apply to individual partners in a partnership. That is because partnership decisions are made per the partnership agreement and/or state statute. Typically, that involves a majority (or specified super majority) of the partners agreeing on behalf of the partnership as to how much it will make as an ER contribution to the profit sharing portion of the plan. If the surrounding circumstances and indicia point to the decision really being made by the individual partners, A deciding for an extra $20,000 and B deciding none, then that will be a disqualified CODA.

One factor, in my opinion, would be the fact that it was 'no skin off of B's nose'. That is, B really did not participate as a partner in the decision of P to make the extra $20,000 contribution for A, because A alone bears that cost against her share of the net profits of P. That suggests that the real decision was an individual one made by A, not a partnership decision made by A+B.

[12AX7]

I appreciate the thoughtful and thorough response you crafted and can understand the nuances between the partner/sole prop as ER and EE. In either event, for partnership plans, I 'm currently not creating separate allocation groups so as to not risk a potential deemed CODA. I have yet to hear of the IRS "disqualifying" such an arrangement, but I was told by an ERISA attorney that the IRS will not issue a DL for a partnership plan with this provision.