Confused Self Directed Solo 401k Plan - Trust vs Custodial Account

[SwimmingInBowelsOfERISA]

I was approached by a business owner (no other EEs) with a solo-k plan that he started about a year ago. The plan doc was setup by a plan administrator "specializing" in self-directed IRAs/solo-ks. The business owner was instructed by the admin official to go to his bank (he recommended a specific, large bank that I won't mention), and open up a checking account under the business's EIN, and make contributions, rollovers, and transactions through that account. He did as instructed, made an indirect rollover contribution via check, made a contribution for the year, and started purchasing non traditional assets (real estate to be specific).

Am I mistaken in that this MUST be a trust account with a separate TIN? I have consulted many other experts and other banks, and the general concensus (with a couple exceptions, particularly the admin who told him to setup the account in this way) is that this cannot be a qualified account. Is there such a thing as a "custodial" account setup through a bank that can serve in this manner? I'm getting some contradictory information from different sources that this MAY be considered proper by the IRS.

Any insight would be GREATLY appreciated.

[ETA Consulting LLC]

A checking account may be a plan asset. The checking account should be set up in the name of the plan (e.g. XYZ solo (k) Plan); not merely the company. You, generally, must contain a Chinese wall between the plan's assets and any other assets of the Company. A checking account that is properly set up by the plan can accomplish that.

Good Luck!

[Mike Preston]

There is no question about what the correct thing to do is: a trust account with a separate TIN (Trust Identification Number)

With that said, I run across a gazillion plans established just as you described: an account set up at a random financial institution under the auspices of the Employer's EIN.

In addition, I run into even worse: an account set up at a random financial institution under the auspices of the Plan Sposnor's SSN!

I think the IRS takes a pragmatic approach to these things. As long as all the taxable reporting is done and as long as the accounts are treated properly (no comingling of personal assets, 1099's are issued when appropriate, withholding done properly) I have never seen the IRS make a big deal out of this issue.

So, while I agree with those who have told you that, technically, the account as established is just another bank account of the employer and the IRS *CAN* take the position that contributions weren't really contributions and rollovers were something else entirely (what? hard to say, but certainly not entitled to favorable tax treatment) I've seen far too many of these mislabled accounts survive audits at all levels to be like Chicken Little when I see it.

I try to get the financial institution to substitute a TIN (which I generally need to apply for on behalf of the client) which they frequently will refuse to do, instead insisting on closing the account and establishing a new account, but strangely some will just substitute the TIN and life goes on.

The alternatives that the client faces are typically beyond their comprehension. If the account is just another account of the employer it means that the plan and plan sponsor suffer catastrophic consequences and they just can't believe that all their deductions are lost, both at the personal level (think 401(k) and rollovers that weren't) and the Plan Sponsor level (think deductions that all go away). Another alternative is to claim some sort of failure and try to fix it under EPCRS. I've never had a client opt for this. And finally, the one that always seems to win the day: change the accounts to a valid TIN either by substitution by the financial institution or setting up a new account, and rely on either winning the audit lottery or counting on being able to argue out of it should it become necessary. There is another option that I won't allow which is to leave things as they are "because my broker said this is fine". Those folks are just not ever going to be my clients.

The reason that so many have gotten away with it for so long with so few consequences is that a Plan Sponsor is free to invest funds with a discretionary financial institution which processes all transactions under a TIN that belongs, not to the Plan Sponsor, but to the financial institution. This goes back to my point that as long as 1099's are properly issued (which virtually guarantees that the tax system doesn't suffer a loss) the IRS will not dig any deeper.

I'm sure others will add their own experiences.

In your specific case there may be enough on the line to convince the Plan Sponsor that formal correction is desirable.

Your case highlights the trust account vs. employer account issue rather starkly. And it makes one wonder what might be different if this Plan Sponsor had done it right from the beginning:

- would the financial institution have declined to open the account had they known that it was supposed to be a qualified plan account?

- would the financial institution have opened the account, but insisted on a completely different protocol and different forms signed and attested to?

- would the folks who sold them the real estate have refused to sell to a qualified plan? [There are investment rules I have no knowledge of personally but I know there are different reporting requirements under certain circumstances.] If so, is the Plan Sponsor now on the hook for misleading them in some way?

Good luck and let us know what happens.

[Bird]

I agree with Mike. It's "wrong" but not necessarily disastrous. I'd start by getting a new EIN for the plan, and submitting a W-9 with that number. They should just change the number on the account.

[SwimmingInBowelsOfERISA]

First of all, I want to thank you all for your responses, especially Mike for providing such a detailed response.

When I spoke with a much larger "self-directed specialist" plan administrator, they told me that they specifically tell their clients to setup under a TIN and NOT to go to two certain large banks which do not want these solo-k accounts. Oddly enough, the administrator he went to told him to go to one of those two banks but to setup the account as a checking account. Seems strange to me.

In any event, I have a "hypothetical" situation. Let's suppose that this particular individual would be FAR better off if we can take the position that the account is a taxable account and not a qualified plan account. Let's say we want to take this position because there were many PTs in the account (due to ignorance rather than malfeasance), AND in one year he's grown a small rollover and contribution to well above the 250k 5500 reporting threshold. If we take the position that the business account is just a taxable account that was improperly setup and thus never qualified as a tax-deferred account, it seems to me he would have four principal issues:

1. will the bank report a 1099-R when he closes or distributes from the account thereby notifying the IRS that the bank considered this a tax-qualified account,
2. in the absence of (1) has any other notification gone to the IRS that this account exists (like a determination letter),
3. in the absence of the previous two but considering worst case scenario that this caught the IRS attention anyway, he is in better standing to argue that the account was improperly setup and since he, the bank, and his CPA considered it a taxable account, they treated the transactions as they would in any other taxable account and paid taxes due, and finally
4. what to do with the existing plan, which has executed documents but was technically never funded?

Any thoughts on this?

[Bird]

As far as what the bank might do with reporting, it is unlikely that they would issue a 1099-R but you really have to ask them. It all depends on how it was set up and how they operate.

Other Qs are above my pay grade.

[Mike Preston]

I can't imagine the IRS would complain about a taxpayer self-imposing the nuclear option. But you don't get to pick and choose which portions you get to impose. It is all or nothing. So, I think contacting a tax lawyer or an ERISA lawyer would be mandatory in such a case.

And Bird, let me nitpick a bit. I agree with what you said but I'd substitute "new EIN for the **TRUST**" for "new EIN for the plan". The SS-4 is filled out slightly differently when the EIN being requested is for the **PLAN**.

[SwimmingInBowelsOfERISA]

Thank you all again. Considering this is all "hypothetical", we would have already consulted an ERISA attorney at a large law firm, especially IF numerous PTs were an issue. And if that attorney was somewhat befuddled by the situation regarding the trust vs custodial account, we would have consulted other ERISA attorneys and TPAs. And if they were likewise not entirely clear, we would have gone to a prominent blog for administrators, actuaries, and advisors to consult with others who may know.

Sometimes, practical knowledge and experience trumps all else. Thanks to each and every one of you again for your contributions. It is GREATLY appreciated.

[Bird]

And Bird, let me nitpick a bit. I agree with what you said but I'd substitute "new EIN for the **TRUST**" for "new EIN for the plan". The SS-4 is filled out slightly differently when the EIN being requested is for the **PLAN**.

Agreed/sloppy writing on my part.

[austin3515]

From a practical perspective: Corporate EIN, with the accoutn properly registered to "John Doe, Trustee, FBO ABC 401(k) Plan."

I know the IRS is starting to get their you know what's all in a bunch about separate EIN's, but the reality is, at least in the small market, separat EIN's do not exist. That was done away with with the advent of daily val plans where the custodian handles all the withholdign remittances and 1099 reporting. There is simply no need for a separate EIN. I have NEVER had separate EIN's for ANY plans, and in dozens of audits over the last 10 or 15 years that has NEVER been an issue.

That;s all the proof I need, even if I am willing to stipulate that you all know more than me

[Soundbc1]

Back in the late '80s, the IRS had a notice out stating that while it was preferable to get a separate EIN for the trust, you could use the companies EIN as long as the investment was titled correctly.

The second firm I worked for went crazy with EINs, the Plan Spomsor had an EIN, the trust had an EIN and the "Administrative Committee" had an EIN.

[SwimmingInBowelsOfERISA]

Interesting. I wonder if in my hypothetical situation that if that business account was titled very similar to the name of the plan per the docs (not exactly the same, but close enough), would that create a complication trying to disavow it as a qualified account???

[Flyboyjohn]

The question of "disavowing" the qualified plan just because it turns out to be the better result with the benefit of 20/20 hindsight (heads I win and tails the IRS loses) strikes me as possibly rising to the level of fraud and me thinks your client needs the services of the proverbial good ERISA attorney (unless you is one).

[SwimmingInBowelsOfERISA]

The question of "disavowing" the qualified plan just because it turns out to be the better result with the benefit of 20/20 hindsight (heads I win and tails the IRS loses) strikes me as possibly rising to the level of fraud and me thinks your client needs the services of the proverbial good ERISA attorney (unless you is one).

All this being hypothetical and as I previously noted he would have already paid an ERISA attorney at a large law firm for advice and consulted several others (and their general consensus being there may a legal ground to stand on despite their lack of experience with this kind of setup), the fact that no participants were hurt and the fact that the client chose to, in Mike's words, "self-imposing the nuclear option", what kind of fraud are you suggesting? The IRS would be paid their taxes due, sans penalties.

I'm not being argumentative and I understand your point, but really who is hurt here? Only the client who got bad advice and is now seeking an expensive, albeit not the most expensive but DEFINITELY not the least expensive, way out?

[Flyboyjohn]

Had a possibly comparable situation where someone did a ROBS deal, turned out to be spectacularly successful investment and when the owner realized he'd turned a large capital gain into ordinary income wanted to go back and find a way to undo the deal.

I probably haven't followed your facts closely enough but if you're confident that the IRS can't and won't "lose" by the disavowal then I'd be more comfortable with the concept.

[SwimmingInBowelsOfERISA]

Had a possibly comparable situation where someone did a ROBS deal, turned out to be spectacularly successful investment and when the owner realized he'd turned a large capital gain into ordinary income wanted to go back and find a way to undo the deal.

I probably haven't followed your facts closely enough but if you're confident that the IRS can't and won't "lose" by the disavowal then I'd be more comfortable with the concept.

Thank you for that insight!

[BG5150]

And Bird, let me nitpick a bit. I agree with what you said but I'd substitute "new EIN for the **TRUST**" for "new EIN for the plan". The SS-4 is filled out slightly differently when the EIN being requested is for the **PLAN**.

You can do these online. Takes two minutes.

[Mike Preston]

Nothing takes two minutes.

[austin3515]

Amen.

2 minutes to get the SSA, maybe... Explaining to the client why it is needed, tracking this new EIN, blah blah blah...

[BG5150]

Amen.

2 minutes to get the SSA, maybe... Explaining to the client why it is needed, tracking this new EIN, blah blah blah...

"The govn't said so." ends a lot of those conversations

[austin3515]

That argument works better when the governemtn actually said-so. But here they have not. They have merely "suggested" it without providing any reasoning behind the basis for the suggestion.