Timing of Sole Prop or Partner deferrals deposits

[Pammie57]

It is my understanding that a sole prop's or a partners earned income is determined as of the last day of their tax year - does his/her deferral $$$$ have to be in by that last day or do they get any kind of a grace period (beyond 7 business days) is it just the election that has to be made by 12/31 (or whatever) and then $$$ can go in as soon as possible or is there a hard and fast guideline on the deposit date.

[Lou S.]

My understanding is that a self-employed person doesn't "know" their income until the tax return is completed and that the election only needs to be in place before the end of the year.

[Bill Presson]

Lou S. is correct.

[jpod]

What does an unincorporated sole proprietor have to do to make an "election"?

[ETA Consulting LLC]

Anything that is easily documented. He could send an email to his accountant or sign a letter and have it notarized. Anytime you're dealing with 'grey' area, you'd just take reasonable steps to justify the election was not actually made after the tax year end. You'd just be prepared to offer it to the auditor in the event the plan is audited and the question is asked.

Good Luck!

[jpod]

What if you make the deposit before the year ends and write on the memo line of the check: "elective deferral contribution to 401(k) plan" or something to that effect?

[Belgarath]

I will also say that there are probably more of these that are "found" in files, properly dated, than anything else I can think of. I would never tell a client to do this, nor do I advocate it, but I must say that in a business that is rife with ridiculous requirements, requiring a signed election prior to the time income is known is mentally arthritic. Someday, when I'm elected dictator, this is the type of foolishness that the IRS will be prohibited from enforcing. (As dictator, I could abolish the IRS, but I'll need someone to collect my income for me!!)

[Bird]

Here's my 2 cents on this subject...

In my perfect world, my clients sign something before the end of the year to make their election. We all agree that the election must be in place by then. Again in an ideal world, they are making the maximum contribution and have the cash flow to get the money in within 7 business days of the end of the year, the date their income is determined.

If they are not doing the max, them I recommend they pick a dollar amount for their election, and not a percentage. There is enough nonsense going on around Oct 14 that we don't need to be waiting for an accountant to get us info and calculate a percentage contribution (along with possibly a profit sharing contribution). But going "there" means there is no reason not to put the money in "right away" (after the end of the year). What difference does it make if someone's income is not determined if they want to put in a dollar amount? (Except to the extent that they need enough income to permit the contribution.) I guess that might make a case for doing a percentage ("I can't put the money in because I don't know the amount") but that is the tail wagging the dog, IMO.

[jpod]

I am focusing solely on an unincorporated sole proprietor. While I have my doubts about whether an "election" before the end of the year for such an individual is really necessary, for the sake of discussion let's assume it is. Does anyone really think that signing a piece of paper, even in the presence of a notary, is an "election"?

[ETA Consulting LLC]

I am focusing solely on an unincorporated sole proprietor. While I have my doubts about whether an "election" before the end of the year for such an individual is really necessary, for the sake of discussion let's assume it is. Does anyone really think that signing a piece of paper, even in the presence of a notary, is an "election"?

Well, you asked the question. I was merely attempting to provide a little for insight, but see you have your own ideas. Not being sarcastic, but I never considered this worth the level of thought it is being given here.

We know the IRS's position. They just don't want the business owner to make the actual decision on how much to defer after the tax year had ended. What could be offered to appease them is something that will be found out in the event the IRS ever audits the plan and asks the question. We can argue back and forth and what we all think would be an appropriate election, or whether or not one is even necessary. Ultimately, we have to feel secure enough in whatever approach we take in the event the IRS audits the plan and asks the question. I will feel more secure in having done something as opposed to nothing; but that's just me. You know, the could avoid even asking the question or scrutinizing the deferrals to this level.

Good Luck!

[jpod]

ETA: Don't get me wrong, your thoughts are appreciated. What I am saying is that if an election prior to January 1 for an unincorporated sole proprietor is required, the word "election" to me implies making some binding commitment to another person which that other person can enforce if the election is not revoked prior to January 1. I don't know how that gets done in the context of an unincorporated sole proprietorship, and to me the only perfectly safe way to proceed (assuming an election is required) is to make the deposit before January 1 with some type of declaration on the check or in some other transmittal associated with the deposit.

[ETA Consulting LLC]

You're right in that making the deposit prior to January 1st is 'a safe way, and probably the safest way', but the entire issue arose because some owners really do not know what their income level will be for the year (or whether or not they'll end up with a profit). Remember, if income is zero (or negative), then the 415 limit is zero. So, as a matter of rule, the IRS took a more lax position in saying that you don't have to make the deposit before year end; we'll actually afford you the time to calculate your income and have the funds removed then. You're only required to have the election by that time. That, in itself, is an appeasement from the IRS; or at least a more liberal interpretation of the rule where you cannot make deferrals from income that was already received.

At the end of the day, they may not challenge it. But in the event they do, it helps you have something in place to show that, at least, a good faith attempt to follow the rule was made. It's not going to be a perfect process, but all is well when all questions are answered during audit and the IRS moves on the other cases. My experience with the IRS during audit has been that they won't press on issues unless something begins to stick out like a sore thumb.

Good Luck!