Timing of Deferral on K-1 income

[Guest Amborg2]

We have partner who would like to postpone deferral on K-1 income till the end of January ... can you provide any guidance on this? Any time limitation on how soon or how late a partner can wait to complete K-1 and make deferral?

[K2retire]

We generally advise not making deferrals until the K-1 has been calculated, often that is in April of the next year or later.

[Bill Presson]

We generally advise not making deferrals until the K-1 has been calculated, often that is in April of the next year or later.

But don't they have to make the election by December 31?

[Bird]

We advise self-employeds to make an election of a dollar amount by Dec 31, and make the deposit within 7 business days of Dec 31. Using a dollar amount avoids the issue of calculating a percentage of an unknown number in order to make the deposit in a timely manner.

I do believe that they have until the time of filing their tax return to make the deposit and claim the deduction. But I'd rather avoid the issue of "late" deposits.

[Belgarath]

See 1.401(k)-1(a)(6)(iii). The election must be made by 12/31.

As to the timing of the deposit, you have potential issues with the DOL if the plan is subject to Title I - i.e. the deposit would need to be made as soon as it can be "reasonably segregated." Now I don't see how you can seriously argue that it can be "reasonably segregated" until the K-1 income is known - but I'm sure there are people who would disagree with me.

If not subject to Title I, then I'm not sure that there is any deadline, other than normal deadlines for deductions, 415 purposes, the normal 12 month rule, etc..

[Guest Amborg2]

Thanks for the responses ... again our concern is to complete testing and any potential refunds on a timely basis. We also cross posted to TagData for insight. I thought it would be helpful for all to cross post that response:

Subject: TAG Answer for .Timing of contribution by a partner

QUESTION

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Background Info:

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One of our clients is an LLC. The partners receive a semi-monthly draw as

part of their compensation. One of the partners would like to delay

completing his

401(k) deferral until the end of January.

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Specific Questions:

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Can you offer any guidance on the timing of contributons by an owner?

ANSWER

Officially, deferrals should be deposited no more than 15 business days

after the end of the month. Unofficially, it depends, it could be the end

of January, or possibly as late as the due date of the sole proprietor's

tax return. See the FAQ from our website below the signature line for

additional information.

For small plans:

The DOL requires elective deferrals to be deposited as soon as the money

can be segregated from employer assets, which basically means ASAP. A late

deposit is a prohibited transaction. The 7 day deposit rule for small

plans provides that a deposit will be considered to be made ASAP if it is

made within 7 days following the payroll date. The final rule was effective

January 10, 2010. Bear in mind, however, that the 7 business day deposit

rule is a safe harbor.

The regulations still require that employee contributions and loan payments

be deposited as of the earliest date on which such contributions or

repayments can reasonably be segregated from the employer's general assets.

Depending on the employer, that time period may still be more than 7

business days. See below.

The unofficial guidance for partner's and self-employed participants still

applies. The deadline could be the end of January, or possibly as late as

the due date of the sole proprietor's or partner's tax return.

Question:

Deposit timing of partner and sole proprietor deferrals

Answer:

The deadline for making a deductible contribution to a plan is the filing

due date of the return on which the deduction is being taken (generally the

employer's return), including extensions. This is true for a sole

proprietor, a partnership or an LLC.

An elective deferral must be deposited as soon as it can be segregated from

the assets of the employer, but no more than 15 business days after the end

of the month. The DOL feels a partner's deferral should be deposited by the

end of January. However, DOL has not formally stated as much, even when the

opportunity presented itself.

Generally, a partner is considered earning his compensation on the last day

of the year. The final 401(k) regulations contained an exception to the

rule precluding the funding of elective contributions before the

performance of services in the situation where the compensation would also

have been paid, but for the election, before the performance of services

and that exception has been retained in the final regulations. The

restriction on the timing of contributions is not intended to prevent a

partner from deferring amounts that are paid to the partner throughout the

year on account of services performed by the partner during the year, and

the final regulations have been modified to clarify this point. However,

self-employed individuals who take advantage of this opportunity to defer

amounts during the year must make sure that the amount contributed during

the year will not exceed the limits (such as the limits of section 415)

that will apply to the individual, based on the individual’s actual earned

income for the relevant period. The new regulation has been reproduced

below.

There is also unofficial guidance that deferrals for self employed

individuals and partners must be deposited within 30 days after the end of

the year. Our understanding is that the 15 business day rule applies to

self employed individuals the same way it applies to employees. That

includes partners, LLC members, and sole proprietors. This position, and

the proposition that deferrals should be deposited within 30 days or by the

end of January, has been stated by various DOL representatives, but has

never been issued as formal guidance. It also seems possible that a

partner’s deferrals can be deposited in conjunction with the tax return

filing, and be timely, but no one in an official capacity has endorsed that

proposition. There are facts and circumstances that must be evaluated in

each situation. That said, the information provided below (from the final

(12/2004) 401(k) regulations is the best (and only) guidance we have.

(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.

The following should be helpful:

Part III

Department of Labor

Pension and Welfare Benefits Administration

29 CFR Part 2510

Regulation Relating to Definition of "Plan Assets"--Participant

Contributions; Final Rule

DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

29 CFR Part 2510

RIN 1210-AA53

The preamble is reproduced below

c. Partnerships

Two comments were received relating to when contributions by partners to

section 401(k) plans become plan assets. The letters represent that, under

26 CFR 1.401(k)-1(a)(6)(ii), a partner's compensation is deemed currently

available on the last day of the taxable year, and an individual partner

must make an election by the last day of the year. They ask when the

monies, which otherwise would be paid to a partner, but for the partner's

election, become plan assets, inasmuch as partners do not receive wages. In

the view of the Department, the monies which are to go to a section 401(k)

plan by virtue of a partner's election become plan assets at the earliest

date they can reasonably be segregated from the partnership's general

assets after those monies would otherwise have been distributed to the

partner, but no later than 15 business days after the month in which those

monies would, but for the election, have been distributed to the partner.

From the Pension Actuaries and Consultants Conference in Washington, D.C.,

on October 9, 1997:

ASPA: If a sole proprietor or partner is deemed to earn income only on

12/31, what is the implication of elective deferrals made by the partner

during the year prior to 12/31? Is a sole proprietor or partner deemed to

earn all their income in one day for all purposes?

IRS: Their income is actually earned throughout the year, regardless of the

fact that it is DEEMED to be earned at year end. Thus, contributions can be

made during the year, but this is done at the peril that the amount

deferred as a percentage of pay is unknown until the year end and could

result in problems.

DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2510

RIN 1210-AB02

Definition of ``Plan Assets''--Participant Contributions

AGENCY: Employee Benefits Security Administration, Department of Labor.

ACTION: Final rule.

SUMMARY: This document contains a final regulation that establishes a safe

harbor period during which amounts that an employer has received from

employees or withheld from wages for contribution to certain employee

benefit plans will not constitute ``plan assets'' for purposes of Title I

of the Employee Retirement Income Security Act of 1974, as amended

(ERISA), and the related prohibited transaction provisions of the Internal

Revenue Code. This regulation will enhance the clarity and certainty for

many employers as to when participant contributions will be treated as

contributed in a timely manner to employee benefit plans. This final

regulation will affect the sponsors and fiduciaries of contributory group

welfare and pension plans covered by ERISA, including 401(k) plans, as

well as the participants and beneficiaries covered by such plans and

recordkeepers, and other service providers to such plans.

DATES: This final rule is effective on January 14, 2010.

. . .

2. In Sec. 2510.3-102, revise paragraphs (a), (b), © and (f) to read as

follows:

Sec. 2510.3-102 Definition of ``plan assets''--participant contributions.

(a)(1) General rule. For purposes of subtitle A and parts 1 and 4 of

subtitle B of title I of ERISA and section 4975 of the Internal Revenue

Code only (but without any implication for and may not be relied upon to

bar criminal prosecutions under 18 U.S.C. 664), the assets of the plan

include amounts (other than union dues) that a participant or beneficiary

pays to an employer, or amounts that a participant has withheld from his

wages by an employer, for contribution or repayment of a participant loan

to the plan, as of the earliest date on which such contributions or

repayments can reasonably be segregated from the employer's general

assets.

(2) Safe harbor. (i) For purposes of paragraph (a)(1) of this section, in

the case of a plan with fewer than 100 participants at the beginning of

the plan year, any amount deposited with such plan not later than the 7th

business day following the day on which such amount is received by the

employer (in the case of amounts that a participant or beneficiary pays to

an employer), or the 7th business day following the day on which such

amount would otherwise have been payable to the participant in cash (in

the case of amounts withheld by an employer from a participant's wages),

shall be deemed to be contributed or repaid to such plan on the earliest

date on which such contributions or participant loan repayments can

reasonably be segregated from the employer's general assets.

(ii) This paragraph (a)(2) sets forth an optional alternative method of

compliance with the rule set forth in paragraph (a)(1) of this section.

This paragraph (a)(2) does not establish the exclusive means by which

participant contribution or participant loan repayment amounts shall be

considered to be contributed or repaid to a plan by the earliest date on

which such contributions or repayments can reasonably be segregated from

the employer's general assets.

(b) Maximum time period for pension benefit plans. (1) Except as provided

in paragraph (b)(2) of this section, with respect to an employee pension

benefit plan as defined in section 3(2) of ERISA, in no event shall the

date determined pursuant to paragraph (a)(1) of this section occur later

than the 15th business day of the month following the month in which the

participant contribution or participant loan repayment amounts are

received by the employer (in the case of amounts that a participant or

beneficiary pays to an employer) or the 15th business day of the month

following the month in which such amounts would otherwise have been

payable to the participant in cash (in the case of amounts withheld by an

employer from a participant's wages).

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[jpod]

If the deferral is to be taken out of the final, year-end "clean-up" distribution to partners, your "DOL clock" starts on the day that distribution is paid. For example, if the final distribution is made to partners on Jan. 10 (non unusual in that it is shortly before the quarterly estimated tax deadline), you apply the time limits under the "participant contributions" regulation starting with Jan. 10 (as opposed to, for example, Dec. 31).