Premature termination of Defined Benefit Plan

[ZakOregon]

Hi there,

I have a small business LLC S-Corp. I have a one person defined benefit in place for the last 5 years. Funded till 2017. In 2018, I am unable to fund the required amount owing to significant personal losses and am considering closing the LLC. I was told by my retirement plan folks that there would be an excise penalty and would still have to fund 2018. That does not seem right. What is the penalty and the process of closure? Thank you in advance!

[Effen]

That sounds correct.  If you are unable to make a required contribution, a 10% excise tax immediately applies. In addition, the required contribution does not go away and the excise tax applies each year until the contribution is made. 

If you haven't already done so, you can freeze the plan and/or terminate it.  This may help avoid additional funding requirements for 2019 and beyond, but there might not be much they can do about 2018 at this point.  

There are some strategies that can minimize the damage, but they are outside the scope of this board.  Ask your "retirement plan folks" or find an ERISA attorney what they suggest.

 

[Larry Starr]

On 11/13/2018 at 12:11 PM, ZakOregon said:

Hi there,

I have a small business LLC S-Corp. I have a one person defined benefit in place for the last 5 years. Funded till 2017. In 2018, I am unable to fund the required amount owing to significant personal losses and am considering closing the LLC. I was told by my retirement plan folks that there would be an excise penalty and would still have to fund 2018. That does not seem right. What is the penalty and the process of closure? Thank you in advance!

It doesn't appear that you are getting adequate advice.

Whether your "retirement plan folks" are fully versed on the actions that can be taken to mitigate the excise tax is unknown from your posting, but appears to not be likely.  It is likely you will have a 2018 excise tax penalty to pay, but that does NOT mean you have to fund the plan (that is, only the penalty is paid, not the funding itself). You said something different and that is not correct; if that is what they told you, then you need better advice.

And there are things that can be done to minimize the penalty.  In any case, it is also true that the penalty would apply ONLY for one year as there is specific action that can be taken to eliminate the funding requirement in 2019 and beyond. You do need to talk to them and see if they can give you more detailed and knowledgeable answers.  If they are a defined benefit shop and understand the detailed operations and complexity of those plans and how to make them work (like, is the actuary part of their practice), then you should be getting different answers than what you say they said, and heeding their advice. However, many pension firms farm are not full service actuarial firms and outsource the real DB work and are not experts in their operation, and if that is the case, you may need to find someone else to guide you.

If you want to call me, I would be happy to give you a little more specific guidance.  My office phone is 413-736-2066.  If I am not there, leave a voice message since that is forwarded to me as an email.  Good luck.

[Effen]

Good response Larry.  

I am wondering if this is a 2017 missed contribution, in which case he might also have a 2018 problem looming.

Zak - are you talking about a contribution that was due in 2018 (ie: for the 2017 plan year), or a contribution for the 2018 plan year that is not required to be deposited until sometime in 2019?

Larry - what did you mean when you said the, "penalty would apply ONLY for one year as there is specific action that can be taken to eliminate the funding requirement in 2019 and beyond. "  Are you referring to terminating the plan before the 2019 plan year?  If he doesn't terminate, why wouldn't the excise tax continue to apply each year?  Even if he can get a $0 requirement for 2019, the 2018 (or 2017?) remains due and the excise tax still applies, doesn't it? 

 

[Kevin C]

When a funding deficiency is reported on the 5500 filing, does the IRS send out a notice of deficiency that would trigger the 100% tax under 4971(b)?

[Effen]

in theory, but I have never seen it in practice.  The only time I have heard this being applied is when the sponsor is being non-cooperative.

 

 

[david rigby]

2 minutes ago, Effen said:

in theory, but I have never seen it in practice.  The only time I have heard this being applied is when the sponsor is being non-cooperative.

I agree.  Never seen it happen.

[Larry Starr]

22 hours ago, Effen said:

Good response Larry.  

I am wondering if this is a 2017 missed contribution, in which case he might also have a 2018 problem looming.

Zak - are you talking about a contribution that was due in 2018 (ie: for the 2017 plan year), or a contribution for the 2018 plan year that is not required to be deposited until sometime in 2019?

Larry - what did you mean when you said the, "penalty would apply ONLY for one year as there is specific action that can be taken to eliminate the funding requirement in 2019 and beyond. "  Are you referring to terminating the plan before the 2019 plan year?  If he doesn't terminate, why wouldn't the excise tax continue to apply each year?  Even if he can get a $0 requirement for 2019, the 2018 (or 2017?) remains due and the excise tax still applies, doesn't it? 

 

I had a nice phone call with Zack.  There is no 2017 missed contribution; the issue is the 2018 required minimum contribution.

Yes, termination of the plan is called for in his situation.  I won't go into the gory details, but it is much worse than just what we see in the posting and termination of the plan is appropriate. Without termination (and a majority owner waiver), the compounding of the excise tax would apply.

[imchipbrown]

Thanks for mentioning the "majority owner waiver" card.