5305-SEP IRA and solo401k

[jjface]

I am potentially in a big mess with my retirement accounts. I opened a 5305-sep ira in 2013 and put in $4k. I'm a sole proprieter with no employees. Before the year end in 2014 I opened a solo 401k. Then:

1. On 8 Jan 2015 or so mailed a check for $10k and contribution form for my SEP IRA to post as a 2014 contribution

2. on 12 Jan 2015 or so mailed a check for $8k and contribution form for my 401k employee deferral and marked it as a 2014 employee deferral contribution.

There is a big debate about 5305-sep IRAs and whether you can have them at the same time as a solo 401k. I'm not convinced I can't. In particular the wording is unclear whether the requirements to use the form are when the sep is set up or whether it is on going. Eg to adopt means to take on at a specific point in time. So I adopted the SEP IRA in 2013 when I didn't have a qualified retirement plan.

I was wondering what everyone thought about the situation and whether there are any easy fixes to just circumvent the issue entirely.

EG

Currently I have $18k deduction for sep/qualified plans in 2014. I have submitted my return for 2014.

I could take my sep ira deduction in 2015. Contribute $10k in my 401k for 2014 as an employer deduction (I believe I have until the 15 April). So the IRS will see

2014. $18k deduction for sep/qualified retirement plans

2015 $10k SEP deduction with a 2015 5498 showing $10k. I don't plan to contribute to the 401k for 2015 in this situation.

That way I didn't take a deduction for both for the same tax year.

[jjface]

Another option that has been suggested was to just withdraw the sep contribution and put it in the 401k.

Not sure about penalties and I assume the earnings are subject to tax.

[Bird]

There is a big debate about 5305-sep IRAs and whether you can have them at the same time as a solo 401k. I'm not convinced I can't. In particular the wording is unclear whether the requirements to use the form are when the sep is set up or whether it is on going. Eg to adopt means to take on at a specific point in time. So I adopted the SEP IRA in 2013 when I didn't have a qualified retirement plan.

I'm not sure there is any debate - you can't use that form if you have another plan, and you are "using" it if you are maintaining a SEP under it.

I'd first ask my investment provider if they have a SEP adoption agreement that doesn't use the IRS form. If so, use it and move on; there might be a little exposure but I don't think I'd get worked up over it. The other option is to roll the money from the SEP to your 401(k). Have the check paid directly to the 401(k). It doesn't really correct the problem but will eventually create distance from it.

[John Feldt ERPA CPC QPA]

Is the Form 5305 your written SEP document? If so, the language in the Form 5305 states "When not to use Form 5305-SEP. Do not use this form if you: 1. Currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP."

[jjface]

Is the Form 5305 your written SEP document? If so, the language in the Form 5305 states "When not to use Form 5305-SEP. Do not use this form if you: 1. Currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP."

Yes and true but the wording of the restrictions on the document can be read to apply to the establishment of the SEP-IRA only which was done in 2013 and not in 2014. I didn't currently maintain a qualified plan at the time I used the form to establish the agreement.

[Mike Preston]

Very inventive. But you have to realize that there really is no debate. If you are audited the IRS will not take that position.

The question you must answer is how much pain/aggravation/money you are willing to endure/spend to correct the problem. As it stands right now the IRS will disallow the $10,000 deduction in 2014. There is only one officially sanctioned method to correct the problem. A VCP submission of Appendix C, Part II, Schedule 3 of Revenue Procedure 2013-12 recognizing the amounts contributed were "Excess Employer Contributions" and propose a correction to either: 1) distribute the excess back to the employer (including earnings) along with a VCP filing fee of $250, or, 2) propose that the excess (including earnings) remain in the SEP along with a VCP filing fee of $250 plus 10% of the excess (including earnings).

If you do the former you will lose the deduction for the amount contributed to the SEP (which you can replace by making a $10,000 additional employer contribution to your 401(k), assuming your 401(k) document doesn't preclude employer contributions).

The problem is that you will most likely need to pay somebody to help you deal with 2013-12 and that expense will, unless you find some kind soul willing to take on the task at below market rates, no doubt seem very expensive to you.

Good luck.

[jjface]

Since I am within the due date of my return, is this not a simple return of excess contributions like all IRAs. I'm not sure why a correction under the vcp would be required. The sep fix it guide reads that this may be possible under the self correction program if it is a return of excess contributions. Essentially I've contributed to something I cannot. This Sep IRA needed to be closed down for 2014 when I took out the solo 401k.

I wouldn't think it was a plan document failure since I am not intending to maintain the sep ira for 2014 and onwards. If I amended the plan document I would be looking to keep it running and adding contributions.

I was just thinking is there time to transfer the plan to a prototype SEP IRA provider or does the contribution timeline prevent that (ie did i need to transfer before the contribution)? I believe the written sep agreement needs to be in place by the due date of the return for deductible contributions to be made in that tax year. So there may be scope to do this?

[Mike Preston]

The document that relates to the account used to receive the contribution has to be executed before the funds are accepted by the financial institution.

I've never really seen the first element of the eligibility for SCP satisfied:

"To be eligible for SCP, the plan sponsor or administrator must have established practices and procedures..."

Besides, it isn't *really* an Excess Contribution scenario because the document, as drafted, certainly allowed the contribution.

This is, technically, a failure that is not contemplated under 2013-12 at all.

But there is a quirk in the VCP procedure that mandates the employer to cop to an error of some sort (even if the employer has doubt as to how to describe the error) and then, and only then, will the IRS respond favorably to a VCP submission. So, I'm suggesting that the officially sanctioned method of fixing what has gone wrong is to call it an Excess Contribution and let the IRS bless whichever treatment you elect.

There is an alternatively nuanced road you can go down. The correction for a Simple IRA (See Schedule 4) is amazing. It essentially is: File VCP, pay $250, promise not to again do whatever bad thing you did before.

So, I see three courses of action for you:

1) SCP, withdraw the money from the SEP-IRA. Keep your fingers crossed that you aren't audited and if you are that this issue doesn't come up, or if it does that the IRS accepts your SC.

2) What I previously described, copping to whatever failure you think makes sense to cop to.

3) A VCP filing that doesn't use the Schedules, recognizing that the correction you are seeking is not available using the schedules but it nonetheless represents a reasonable alternative.

Heck, there may be others!

Good luck again.

[jjface]

"The document as drafted allows the contribution"

But then the whole reason I'm in this mess is because I can't use the document. So with no document no contributions are allowed. That is my reasoning to treat it like a regulat excess contribution.

I can agree I need to correct it in some way. I'll speak to fidelity and see what they suggest.

Thank you for your advise so far.

[Mike Preston]

Can't resist: ROF,LMAO.

[jjface]

If I do #1:

Would I be liable as the employer to the 10% excise tax on excess contributions ie the whole 10k contribution and any earnings? Or would this be treated as if they were never contributed in the first place?

I think the latter since (a) they are not excess contributions under the definition in us code 4972 (i did not breach the contribution limits) and/or b) under 4972©(3) contributions were returned to the employer by the due date (also the distribution sounds like it is described in 4989 © (2) (b) (ii) namely (III) in the case of any plan, by reason of the failure of the plan to initially qualify or the failure of contributions to be deductible.)

How would I report all of this?

Fidelity will issue a 1099-r

I will not deduct the contribution in any year and also include earnings in my income for 2015 File form 5329 for the 10% penalty on those earnings.

Is that it?

Thanks again.

[mbozek]

If OP is going to claim SEP contribution for 2015 will it contradict any statement he made to SEP custodian that it was a contribution for 2014? On the 1040 only the total contribution to the employer plan is listed. Contribution can be made from a SEP, SIMPLE or a qualified plan.

I recollect that a taxpayer has until April 15th to make a contribution to a qualified plan even though the tax return claiming the deduction is filed on an earlier date. There is a similar rule for IRAs which allows a taxpayer to claim an anticipated tax refund as a tax deductible IRA contribution for the same tax year as long as the IRA custodian receives the refund by April 15.

If there is no reporting of SEP contribution being made in 2014 it is unlikely that IRS will figure out what happened within the 3 year audit period. IRS only audits 1% of tax returns with $200,000 or less income.

[jjface]

If I am in the 1% the violation would be spread over numerous years and so larger penalties.. Plus they will look at me harder since I didn't fix it before an audit.

The custodian doesn't track the contribution deduction year just when the contribution is made for a sep ira. Tracking is down to me.

Interestingly I've been looking at the Charles Schwab Protoype (not 5305-IRA) SEP IRA and the adoption agreement has a specific option as follows:

This is an amendment and restatement of an existing Simplified Employee Pension plan (a Prior Plan).

The Prior Plan was initially effective on __________________________________________________________________.

The Effective Date of this amendment and restatement is _________________________________________________.

Note: The Effective Date is usually the first day of the Plan Year in which this Adoption Agreement is signed.

I am seriously considering transferring to Charles Schwab with their prototype SEP IRA and since my contribution was made in 2015 take the deduction for it in 2015 with the CS agreement effective on 1 January 2015 (first day of the plan year).

I'll make an equal employer prior year contribution to my solo401k to cover the $10k so my tax return/taxes remains the same.

The trustee to trustee transfer is not reportable, my 2014 tax shows a $18k deduction to a qualified plan within my limits and made within the time limits, my 2015 tax will show a $10k deduction to a sep/qualified plan with the IRS receiving a 5498 indicating a $10k contribution to a sep received in 2015. My 2015 Sep is now a prototype so will be valid to continue to contribute to if I so choose.

I think this will all work because 401(b) allows certain retroactive changes in plan within specific time periods. I believe I am still within the time limits - since the contribution was made in 2015 (and I believe the failure was triggered by contributing to the SEP IRA and 401k in 2015) this should be by 15 April 2016.

This would mean there is no plan document failure if remedied in time which means no disqualification of the plan and no need to correct anything. This has been useful - http://www.irs.gov/irb/2013-04_IRB/ar06.html . Specifically Part III Section 5.01.

I see here why this case is not shown in the SEP fix it kit since that only covers mainly "operational failures" and not one of the other three types of failure leading to disqualification of the retirement plan. This falls under "plan document failures" I believe.

Also :

.08 Generally, none of the correction programs are available to correct failures that can be corrected under the Code and related regulations. For example, as a general rule, a Plan Document Failure that is a disqualifying provision for which the remedial amendment period under § 401(b) has not expired can be corrected under provisions of the Code through retroactive remedial amendment.

[Bird]

I think what you suggest works. I think you could even restate the SEP to the Schwab document retroactive to 1/1/14, roll the account with the $10000 contribution, and not go through the trouble of making the extra deposit. Your way is probably marginally safer, in terms of exposure, going from .005% risk of problems to .001%, or maybe 0.

I give you a lot of credit for thinking this through.