Retirement Plan in sale of business

[Danny CPA]

We have a client that is looking to acquire an unrelated business to expand into a new market. They are going to fund the purchase as an asset sale, and hire the seller as an employee to transition the business, retain clients/contracts, etc.

Our client currently has a 401(k) safe harbor match with no profit sharing allocations.

Currently, the buyer and seller are not close in terms of the selling price (say $500,000).

The idea has been floated that when the seller is brought on as an employee, we count his prior service so he (and the other employees that come along) are eligible for the 401(k) plan immediately. In addition, we would then give the seller a profit sharing allocation up to the 415 limits assuming some performance metrics are met. This additional contribution would be used to reduce the current difference in sale price (the buyers would pay a little bit more overall, but would have a tax deductible expense, and the seller would have a deferral of income on the contribution).

So, for example, the compensation we pay the seller would be under the HCE limit (say $75,000), and he would get a $53,000 profit sharing allocation, with no other employees receiving a profit sharing allocation.

Since this is an asset sale, I don't believe that there would be a lookback year to determine HCE status, and since only NHCEs received a profit sharing allocation, there would be no minimum gateway or top heavy minimum issues.

Is there something I am completely missing, or would this work? Does anyone have experience with this sort of set up? The other idea that has been floated around has been a cash balance plan.

[shERPA]

The profit sharing contribution should work, assuming the plan document language supports this sort of allocation.

It is common to credit prior service with a selling entity for employee eligibility and vesting in the buyer's plan, so nothing unusual there. Assuming they are buying the assets from the seller's corporation, the seller won't have ownership in the buyer and the selling entity is not contracted to provide management services then the seller should be an NHCE.

Cash balance won't work as they have to meet 401(a)(26) participation requirement.

If the current safe harbor matching 401(k) would be top heavy but for the SH exemption, adding a profit sharing contribution to the plan would blow this exemption, so TH minimums could then be triggered due to deferrals and match received by key employees in that plan. You could avoid this with a separate PS plan that covers only the seller. Since he is an NHCE and non-key, and the 401(k) does not rely on the PS plan to pass coverage or non-discrimination the two plans would not be a RAG under 416 and the SH plan could maintain its TH exemption.

[Mike Preston]

This is not without controversy as to the ability to deduct in excess of 25% of $75,000. There are some who argue, such as myself, that the 25% limit is calculated with respect to those who actually benefit under 410(b).

What is interesting in this case is that there is an employer contribution (the match) that falls within the 25% calculation such that the total employer contribution between the $53,000 and the match would no doubt be much less than the 25% limitation.

So, the question is whether the 410(b) calculation can aggregate between the two plans.

[shERPA]

Do the plans have to aggregate under 410(b) for the deduction limit to apply to both plans combined? Section 404(a)(3)(A)(iv) provides:

(iv)2 or more trusts treated as 1 trust

If the contributions are made to 2 or more stock bonus or profit-sharing trusts, such trusts shall be considered a single trust for purposes of applying the limitations in this subparagraph.

The 401(k) with SH match is a "profit-sharing trust". The 25% deduction limitation applies to compensation of employees "benefiting". Assuming at least a handful of employees receive match (ignoring that they are all "benefiting" in the match if they are eligible for it but just don't defer) it's hard to imagine that between the two plans there is not room for this $53K PS contribution. And 404 doesn't say anything about requiring aggregation under 410(b), it has its own stand-alone aggregation for the deduction limit.

[jpod]

Why must there be 2 plans? I think it's a terrific idea, but it assumes that the seller's owner is willing to work for the salary (plus ps contribution of $53,000) which you describe.

[Danny CPA]

Thank you everyone. I should have clarified that the existing plan is not top heavy, and is not particularly close at this point. The plan document does have the cross-tested and each individual in their own group provisions as well. It sounds like it would work, and we would do all of this within the single plan that we have.

shERPA - You mentioned in your message that the cash balance plan would not work due to the 401(a)(26) participation requirement. If the CBDB covered ONLY this NHCE and no HCEs benefitted, wouldn't that qualify for an exemption to 401(a)(26)?

[shERPA]

shERPA - You mentioned in your message that the cash balance plan would not work due to the 401(a)(26) participation requirement. If the CBDB covered ONLY this NHCE and no HCEs benefitted, wouldn't that qualify for an exemption to 401(a)(26)?

Yes, you'r right, there is an exemption for plans that cover NHCEs only. I'm so used to dealing with CB/DB plans for owners that this doesn't come up too often.