Self employed - IRA transfers funds to plan for employer contribution

[Belgarath]

Say a self employed wants to make a profit sharing contribution. I don't see a problem with transferring the contribution from his personal IRA, AS LONG AS it is treated/reported as a taxable distribution to him, and not a non-taxable transfer/rollover. Any other opinions?

I'm sure this has been discussed before, but I couldn't find anything using the search function.

[Bird]

No problem.  A self-employed person is indistinguishable from his or her business so it doesn't matter where the money comes from.

[jpod]

I am sure there is a very good(?) reason for doing this, but I can't think of one.  Anyway, if this individual is going to do this, I suggest that he first take the IRA distribution and deposit it in his personal checking account, then write a check made payable to the profit sharing plan, rather than some type of direct transfer.  That will eliminate the appearance of a PT with respect to the IRA assets. 

[Bird]

I think it was implied that it would go through his personal checking account; I don't think it could be done otherwise, at least not without jumping through hoops.

[jpod]

I don't think it was implied at all.  I suggest you read it again, especially the beginning of the second sentence.  The tax reporting isn't necessarily indicative of the way the money got from point A to point B. 

[Belgarath]

This was sent directly - not through the checking account. But it was sent at the instruction of the IRA account holder. Never in the possession of the individual, but the IRA institution processed it as a fully taxable distribution. So a 1099 will be issued showing a distribution, and it'll be declared as income on the tax return.

'Twould be nicer if they had done it jpod's way, but it does seem like a no harm no foul situation. But perhaps an auditor would disagree.

P.S. as you might expect, as usual, we were informed after the fact...

[CuseFan]

Takes a taxable distribution from IRA of $X and then makes a tax deductible PS contribution of $X? Why? Why not just roll from IRA to PSP if you want the funds in that plan (for a loan maybe)? If under age 59 1/2, IRA incurs penalty tax, creating a losing net position. Not to mention the need for sufficient earned income from business activity because the IRA distribution is not. You say it's already done, so questions are moot, but I'm sure I'm not the only one extremely curious as to why someone would think this was a good idea.

[Belgarath]

Sole prop, but has employees who participate. Apparently had no other readily available funds to make contribution, so did the IRA thing. It was apparently a liquidity issue, and tax "efficiency" wasn't an issue that concerned him. I'm deducing this from snippets of information - the "why" isn't ultimately really my business. I'm more concerned with whether it creates a more serious issue.

He's over 59-1/2, so no premature distribution issues.

[jpod]

An aggressive IRS agent will/may say that the transfer of IRA assets to his profit sharing plan in order to make contributions for his employees is a PT, in which case his entire IRA blows up for tax purposes.  One would hope that the IRS would agree that it should be treated as a constructive distribution to him, followed by a contribution of his personal funds to the profit sharing plan, because that's how it is being tax-reported, but I'm not sure if there is any legal authority out there to cite.  

[Larry Starr]

Jpod: an IRS agent who makes that argument will be wrong. If all parties treat it as a distribution, it IS a distribution. And no agent would ever even see where the money came from.  If it is treated as a distribution, then he is free to do with it what he wants. The only thing that hasn't been mentioned so I will mention just to make sure nothing is overlooked: the recontribution of these funds to the PS plan must meet the deduction rules applicable to the sole prop and the income therein WITHOUT reference to this transferred money.  I assume that is assumed! :-)

[jpod]

Larry Starr:  Of course he/she would be wrong, but so what?  Clients don't like to have aggravation, much less paying professional fees to explain to an IRS agent why he/she is wrong.   I was only suggesting that the paper trail leading down the path of least resistance would have been to deposit the check then write another check.    

[Bird]

OK, yeah it would look better if it went through the personal checking account but I agree - it is ok if it went directly.

[Belgarath]

Guess what we just found out? They DID, in fact, have it distributed and deposited to personal checking account, then directly transferred it from the checking account to the plan. They just told us incorrectly what they actually did. Anyway, the discussion has been informative for me, so I thank you all.

[Bird]

Not surprising.  As I said earlier, doing it directly would involve some hoop-jumping.

[Larry Starr]

23 hours ago, jpod said:

Larry Starr:  Of course he/she would be wrong, but so what?  Clients don't like to have aggravation, much less paying professional fees to explain to an IRS agent why he/she is wrong.   I was only suggesting that the paper trail leading down the path of least resistance would have been to deposit the check then write another check.    

You are setting up a straw man argument.  First, you are saying that an aggressive IRS agent is going to do the wrong thing!  No; they mostlyu understand the law and it will be an extremely rare agent that is going to make up their own rules and take a wrong headed position and fight for it.  Then, you are saying the client won't want to pay for the work to explain, so avoid it by not doing the action. Again, no.  If a plan is being audited, it is being audited for reasons having NOTHING to do with this transaction.  If the agent brings it up, it is a two minute conversation we will have and then it will be dropped (because if she pushes it,  I would quickly suggest that she consult with her boss since we will strongly contest such a position).  For those reasons, it is a non-issue. If they did it the non-traditional way, it is still a non-issue.

The comment you made that I had a problem with is this: An aggressive IRS agent will/may say that the transfer of IRA assets to his profit sharing plan in order to make contributions for his employees is a PT, in which case his entire IRA blows up for tax purposes.

You cannot run your business on an assumption of a stupid argument from an IRS agent that has no basis in fact.  It is NOT a PT, and the IRA does not blow up.  

Ths IRS agent would be wrong, and THAT is the "so what".  So what?  That's what.  And it matters.  IRS agents are far from omnipotent.  I find most agents are very willing to listen to advice from people they understand know much more about this business than they do.  They actually are very good students if you treat them that way and help them learn how things work. I take the time to educate them, much as I do my clients, their advisors, and others in our industry.

FWIW.