Permanency issue

[R. Butler]

401(k) plan was established in 2013. Plan sponsor wants to terminate the plan now. Two owners rolled money into the plan at inception. The only other money in the plan is 401(k) money of the participants; despite initial intentions no employer contributions have been made to the plan. No loans were ever taken on the rollover money (or any other money for that matter).

A couple of questions:

1. Would the IRS have a permanency issue with this plan terminating? Although I know it is subjective most opinions suggest two years for a DC plan with employer money. Not sure why it would be different if there is not employer money.

2. Assuming there is a pemanency issue what would be the cosnequences? Employee deferrals & trust earnings counted as income? Initial rollovers disallowed? Anything else

Thanks in advance for any guidance

[My 2 cents]

Not a practitioner in that area, just putting in my non-expert thoughts.

Are the owners willing to testify, under oath, that at the time the plan was created it was their intention to maintain the plan indefinitely?

The reason I ask this is that if the IRS comes to the conclusion that the plan was not intended to be permanent, they could disqualify it retroactive to inception. In that case, the validity of the rollovers could be called into question, resulting in the amounts rolled over being treated as ordinary income, interest, penalties etc., making it pretty unpalatable to the owners, perhaps to the extent that they would want to challenge the ruling in the tax court.

Not to impute any bad motives here, but was the primary reason to establish a 401(k) due to 401(k) assets having better protection under bankruptcy proceedings than IRA money?

So, out of curiosity, what changed from last year?

[Lou S.]

It depends on the reasons for terminating. Some sets of facts it would be perfectly fine, others the IRS might have issues with the permanency rules.

[Peter Gulia]

Some fact-finders might evaluate the credibility of the employer's statement that it intended the plan to be permanent by considering whether the proffered reason for ending the plan is one that a prudent person would not have foreseen when the employer created the plan.