401k deposit vs payroll timing for 1-person plan

[TPApril]

CPA for an Attorney who has her own plan (no employees) has set up payroll for the end of each month, but plans to deposit 401(k) each month prior to the payroll date (ie the 20th). Is that okay?

[PensionPro]

 

[ESOP Guy]

Are you asking if they can deposit 401(k) deferrals before the actual wages are earned?  

[TPApril]

ESOP Guy - yes I am, in this case for the one person company, which is a corporation. Payroll is processed monthly at the end of the month.

By comparison, in another situation, how about for a large 401(k) plan where the payroll period ends every 15th and last day of month, and they cut they payroll checks on the 5th and 20th following the end of the period - I have seen HR teams that are so anxious about depositing late that they deposit the day they are finalizing payroll, ie the 18th and 28th, ie before the paycheck cut date.

 

[Kevin C]

The prefunding prohibition for deferrals is here:
 

Quote

 

1.401(k)-1(a)(3)(iii)(C) Contribution may not precede services—(1) General rule. Contributions are made pursuant to a cash or deferred election only if the contributions are made after the employee's performance of service with respect to which the contributions are made (or when the cash or other taxable benefit would be currently available, if earlier).

(2) Exception for bona fide administrative considerations. The timing of contributions will not be treated as failing to satisfy the requirements of this paragraph (a)(3)(iii)(C) merely because contributions for a pay period are occasionally made before the services with respect to that pay period are performed, provided the contributions are made early in order to accommodate bona fide administrative considerations (for example, the temporary absence of the bookkeeper with responsibility to transmit contributions to the plan) and are not paid early with a principal purpose of accelerating deductions.

 

For your example of the company with pay dates on the 5th and the 20th that covers services through the end of the prior month or the 15th, respectively, they are fine depositing when they finalize payroll, since that will always be after the date all of the services for that payroll have been performed. 

For the attorney example, it may not be clear.  Since it's a corporation, the applicable question is what period of service is covered by the monthly payroll?  The deposit needs to be after all of the services covered by the payroll have been performed.  With only the owner on the payroll, I could see that the question may not have come up before.  The safest option would be to deposit at the end of the month when the paycheck is issued.  But, depending on the situation, depositing on the 20th may be acceptable.

 

[Larry Starr]

2 hours ago, TPApril said:

ESOP Guy - yes I am, in this case for the one person company, which is a corporation. Payroll is processed monthly at the end of the month.

By comparison, in another situation, how about for a large 401(k) plan where the payroll period ends every 15th and last day of month, and they cut they payroll checks on the 5th and 20th following the end of the period - I have seen HR teams that are so anxious about depositing late that they deposit the day they are finalizing payroll, ie the 18th and 28th, ie before the paycheck cut date.

 

While I think it is just plain stupid to set it up this way (for a one man business they can't make the deferral deposit on or after the paycheck is cut????), more than likely it would be ok.  

Here's the caveat.  Since he is being paid only at the end of the month, on the 20th he has already provided 2/3 of the month's service.  As long as his 2/3 of the month's income is LESS than the monthly deferral, it is hard to see where anybody will make a fuss. The contribution cannot (generally) precede SERVICES; that is not the same as not preceding the payroll check.  

The large 401(k) company noted above has the same situation since they are depositing the check AFTER the service has been rendered, even though that is before the date on the paycheck.  Both cases will be arguably ok, but it might require some 'splainin to an uninformed auditor.  FWIW.

[Kevin C]

16 hours ago, Larry Starr said:

Here's the caveat.  Since he is being paid only at the end of the month, on the 20th he has already provided 2/3 of the month's service.  As long as his 2/3 of the month's income is LESS than the monthly deferral, it is hard to see where anybody will make a fuss. The contribution cannot (generally) precede SERVICES; that is not the same as not preceding the payroll check.  

???????

Under the regs, an amount deposited before the services are performed is not deferrals.  Say the owner defers $1,500 per month, gets paid for the entire month at the end of the month and deposits contributions 1/3 of a month early.  Since the deposit precedes 1/3 of the service, 1/3 of the "deferral" deposit isn't deferrals.   That makes 1/3 of the deposit ($500) a profit sharing contribution.  That in of itself may not be a problem, but it also means that only $1,000 of the elected $1,500 of deferrals for the month has been deposited.  If she tries to count $500 of the next monthly deposit as covering the last $500 from the prior month, it will be a late deposit. So, another $500 deposit on or after the end of the month would be needed to avoid late deposit issues.  I'll be the first to agree that in this case, the rule is silly, but it is what it is.  The mess can be avoided by depositing on the pay date, or possibly by documenting somehow that payroll is paid 1/3 of a month in arrears.  While it may be unlikely to ever come up, if it does become an issue, it will be about 2 years or more down the road, which makes clean-up more difficult and usually more expensive.

[ESOP Guy]

Isn't one possible solution is to come up with some documentation that says the check paid on the 30th of every month is for services rendered from the prior months 19th to current months 18th? 

So the deposit is now on the 20th and he is paid on the 30th for a months services ending on the 18th  Everyone agrees that can be done as far as I can tell.

Although it seem easier to just cut the check and make the deposit on the 30th. 

[Larry Starr]

6 hours ago, Kevin C said:

???????

Under the regs, an amount deposited before the services are performed is not deferrals.  Say the owner defers $1,500 per month, gets paid for the entire month at the end of the month and deposits contributions 1/3 of a month early.  Since the deposit precedes 1/3 of the service, 1/3 of the "deferral" deposit isn't deferrals.   That makes 1/3 of the deposit ($500) a profit sharing contribution.  That in of itself may not be a problem, but it also means that only $1,000 of the elected $1,500 of deferrals for the month has been deposited.  If she tries to count $500 of the next monthly deposit as covering the last $500 from the prior month, it will be a late deposit. So, another $500 deposit on or after the end of the month would be needed to avoid late deposit issues.  I'll be the first to agree that in this case, the rule is silly, but it is what it is.  The mess can be avoided by depositing on the pay date, or possibly by documenting somehow that payroll is paid 1/3 of a month in arrears.  While it may be unlikely to ever come up, if it does become an issue, it will be about 2 years or more down the road, which makes clean-up more difficult and usually more expensive.

You're over thinking (I think).  Using your example: assume he will defer $1,500 per month.  What you left out is how much he earns per month, so let's make it $4,500.  Now, they make the deferral 1/3 into the month, at which point he has earned $1,500 (1/3 of $4,500) and the deferral does not exceed 100% of his income earned at that point so it is just fine.  There's nothing that says the deferral for the month has to be pro-rata during the month.  This is a one man business; he could certainly say his deferral rate is 100% of his income until a monthly maximum of $1500 is reached.  Does that help?

[Bird]

On 7/31/2018 at 3:17 PM, Kevin C said:

For your example of the company with pay dates on the 5th and the 20th that covers services through the end of the prior month or the 15th, respectively, they are fine depositing when they finalize payroll, since that will always be after the date all of the services for that payroll have been performed. 

I think this nails it.  I believe it is implicit that "all" of the services for the pay period must have been performed.  Why they chose to use the "performance of services" phrase without that clarification is unknown to me but seriously, it makes no sense to have deferrals deposited well before a paycheck is cut - in a normal situation, someone could elect to stop their deferrals or otherwise change them right up until the pay date, or at least a few days before.  

I guess you could argue that it was deliberate but it's just weird.  I think we all agree that the idea is stupid.

[Larry Starr]

22 hours ago, Bird said:

I think this nails it.  I believe it is implicit that "all" of the services for the pay period must have been performed.  Why they chose to use the "performance of services" phrase without that clarification is unknown to me but seriously, it makes no sense to have deferrals deposited well before a paycheck is cut - in a normal situation, someone could elect to stop their deferrals or otherwise change them right up until the pay date, or at least a few days before.  

I guess you could argue that it was deliberate but it's just weird.  I think we all agree that the idea is stupid.

First time in 40 years I've ever seen a client do something stupid! :-)