Terminating Safe Harbor Plan, Schedule C income

[401(k)athryn]

I have a 3% nonelective safe harbor 401(k) Plan that is terminating effective 10/31/2016. The safe harbor is to be calculated based upon compensation from January - October. This is due to a business acquisition, so safe harbor status is maintained.

There is one owner who receives Schedule C income. Safe Harbor has been deposited for the 3 non-owner employees throughout the year. The owner has taken $10,000 distributions periodically and the bookkeeper has made 3% safe harbor deposits based upon these amounts to the owner's account.

The owner's actual earned income for the year will not be determined until sometime in the first quarter of 2017, but we would like to have all assets paid by 12/31/2016 to prevent another plan year. So...how do I calculate the owner's safe harbor contribution from 1/1/2016 through 10/31/2016?

1) Treat him as having earned $0. This would be a problem because, not only did he have safe harbor deposits, but he also deferred during the year.

2) Have the CPA estimate his earned income from 1/1/2016 through 10/31/2016 and calculate the safe harbor for the owner based upon this estimate.

Any other options? Has anyone dealt with this conundrum? Thank you!

[Bird]

I might be tempted to give the owner a choice - use $0 and avoid another plan year, but have all sorts of nasty consequences as you note, or wait until after the end of the year and then pro-rate comp over 10 months...or don't have a short year at all; the others' comp will presumably be self-limited by the acquisition.

There is an argument that a self employed individual earns all of his or her income on Dec 31, but I think it is reasonable to pro-rate. Honestly I don't think it is reasonable to estimate it but others may differ.

[RatherBeGolfing]

Is there a reason why another plan year is a big deal? If you do all your other distributions in 2016 and you are left just the one owner to deposit and distribute in 2017 when you can accurately determine comp, the 2017 plan year should be a very minor inconvenience that could be dispatched in a few hours.

Am I missing a reason why 2017 must be avoided even if doing so creates more problems than it solves? Not trying to be flippant about it, I just don't see a problem with going into 2017 to do it right.

[K2retire]

Is there a reason why another plan year is a big deal? If you do all your other distributions in 2016 and you are left just the one owner to deposit and distribute in 2017 when you can accurately determine comp, the 2017 plan year should be a very minor inconvenience that could be dispatched in a few hours.

Am I missing a reason why 2017 must be avoided even if doing so creates more problems than it solves? Not trying to be flippant about it, I just don't see a problem with going into 2017 to do it right.

Typically it's because no one wants to pay for another year of administration.

[401(k)athryn]

Thanks for the input! You are right that it is not really a big deal to let this plan continue into 2017, but I did not factor in a 2017 filing and continued communications in my termination fees. In addition, the company is shutting down following the asset sale, so I want to wrap it up while the Trustee is still readily available. Either way, I do see going into 2017 as an option if I take the most conservative approach here.

I would still prefer to use an estimate of earned income, which the CPA has offered to provide.

Thanks!

[RatherBeGolfing]

Is there a reason why another plan year is a big deal? If you do all your other distributions in 2016 and you are left just the one owner to deposit and distribute in 2017 when you can accurately determine comp, the 2017 plan year should be a very minor inconvenience that could be dispatched in a few hours.

Am I missing a reason why 2017 must be avoided even if doing so creates more problems than it solves? Not trying to be flippant about it, I just don't see a problem with going into 2017 to do it right.

Typically it's because no one wants to pay for another year of administration.

I agree that is normally the clients position. Maybe I'm just a little conservative when it comes to things like this and I simply wouldn't give the client an option that cuts corners to save $.

[BG5150]

If all the assets were gone by 12/31 except for the owners, and all the plan doc stuff was up-to-date, I'd charge like $300 to file the final 1-participant plan 5500. Could even do it on an EZ.

[RatherBeGolfing]

If all the assets were gone by 12/31 except for the owners, and all the plan doc stuff was up-to-date, I'd charge like $300 to file the final 1-participant plan 5500. Could even do it on an EZ.

Yep, that was how I looked at it too. And if I missed that when I did my final fee calculation I would just eat the cost and get it over with.

[ETA Consulting LLC]

I might be tempted to give the owner a choice - use $0 and avoid another plan year, but have all sorts of nasty consequences as you note, or wait until after the end of the year and then pro-rate comp over 10 months...or don't have a short year at all; the others' comp will presumably be self-limited by the acquisition.

There is an argument that a self employed individual earns all of his or her income on Dec 31, but I think it is reasonable to pro-rate. Honestly I don't think it is reasonable to estimate it but others may differ.

I like the way you articulated this because it outlines the major issues. I'll venture to say the choice by the owner would be to either take zero compensation for the short plan year or terminate at year and take full compensation. Like you said, technically, the owner receives his compensation on the last day of the taxable year. So, for consistency, his 415 limit is going to be zero until this day.

I won't venture to say the idea of prorating compensation is not reasonable, but there does appear to be a clear choice to avoid the issue altogether. That would be to either terminate on December 31st or take zero Compensation should you choose to terminate before then.

Good Luck!