determining partnership contributions when ownership changes

[Santo Gold]

We have a calendar year plan with 10 partners, and lets say all 10 have equal ownership in the business (10% each). The business entity is a partnership. A 3% safe harbor employer contribution exists; there is also an additional profit sharing contribution.

On February 1st, two of the partners leave and their ownership shares are divided equally among the remaining 8 owners, such that 8 owners now own 12.5% of the business.

At year end, for purposes of determining the total employer contribution, the self-employment calculation must be performed in order to determine the amount of contribution to the employees and the owners. The ownership percentage for each owner is a factor in this determination. How is this determined when the ownership changes in during the year?

Thanks

[Lou S.]

For what purpose?

The partnership agreement should spell out how contributions are allocated.

For certain IRS tests, the highest percentage owned at anytime during the plan year is used.

You should probably talk to the CPA as to how they are allocating expenses for the pension contributions.

This is just a guess but I would suspect that all partners (including the departed) are going to be responsible for their own contributions and that the contributions for non-partner employees are going be split equally between the remaining 8 partners, but there may be some agreement that the 2 departing partners will be paying some of the ee cost, though that's doubtful as collecting those contributions can sometime prove problematic in practice.

[Santo Gold]

Lou S - The purpose is for determining that particular owner's share of the non-owner employer contributions. If the ownership had not changed, then each owner would be responsible for 10% of the total non-owner employer contributions. But since there was a change, does that mean that (1) the 8 remaining owners are responsible for 12.5% of the contribution while the 2 owners that sold their shares are responsible for 0.00%? (2) All 10 owners are still responsible for 10% each (3), is the ownership for this purpose pro-rated based on how long and how much each owner "owned" throughout the year?

You idea that it would be split equally among the 8 remaining partners seems to make sense. Maybe the sales agreement between the partners would address this. But if it does not, are we left with choosing whatever is reasonable?

[Lou S.]

There is what is reasonable, and there is what is practical. Sometimes they are not the same.

I would assume the partnership would determine this, preferable before the fact, but possibly after the fact.

Any of your 3 scenarios might be used and each would be reasonable in my opinion. But I am not a CPA. That would be the first person to talk to in this situation if the partnership sell agreement doesn't cover it.

[Kevin C]

The only way you will find out how they split the employee contributions among partners is to ask them. Among our clients, the two most common methods are based on ownership % and based on partner earnings.