Mid Year Change in Entity (SP to S-Corp)

[BrownTrout]

I've looked all over the boards here and still can't seem to find a definitive answer to this question so I thought I'd take a crack.

Facts:

• Company is a sole proprietorship on 1/1
• On 7/1, company changes to an S-Corp. No change in ownership (the former proprietor owns 100% of the new S-Corp shares) and no change in business operations. Change in entity was done for tax purposes only
• On 9/30, S-Corp adopts a 401(k) plan with effective date of 1/1

Questions:

• Does service with the sole proprietorship count toward service eligibility for the plan even if the plan docs don't specifically call out the sole proprietorship as a participating employer?
• Is compensation earned by participants under the sole proprietorship included in plan comp for the year?

Seems like such simple questions and common sense tells me that service time should count and comp should be included since the only change made was for technical tax reasons (i.e., no change in ownership and no change in operations). However, I've looked and looked and only find conflicting information. Any clarifying thoughts would be appreciated!

[Bird]

You are on the right track.  I won't answer your specific questions because the correct approach, at least the way we would do it, is to have the sole prop be an adopting employer.  All service would count and contributions for the year would come from both entities.  

[Lois Baker]

Any "predecessor employer" language anywhere in the document?

[Larry Starr]

12 hours ago, BrownTrout said:

I've looked all over the boards here and still can't seem to find a definitive answer to this question so I thought I'd take a crack.

Facts:

• Company is a sole proprietorship on 1/1
• On 7/1, company changes to an S-Corp. No change in ownership (the former proprietor owns 100% of the new S-Corp shares) and no change in business operations. Change in entity was done for tax purposes only
• On 9/30, S-Corp adopts a 401(k) plan with effective date of 1/1

Questions:

• Does service with the sole proprietorship count toward service eligibility for the plan even if the plan docs don't specifically call out the sole proprietorship as a participating employer?
• Is compensation earned by participants under the sole proprietorship included in plan comp for the year?

Seems like such simple questions and common sense tells me that service time should count and comp should be included since the only change made was for technical tax reasons (i.e., no change in ownership and no change in operations). However, I've looked and looked and only find conflicting information. Any clarifying thoughts would be appreciated!

As if often the case, the wrong questions are being asked. Instead, the questions asked should be "what does the client want to do" with regard to the time it was a sole prop.  Normally, the sole prop (which is still in existence; it NEVER goes away legally until the sole prop dies) would adopt the plan and all predecessor activity would count.

When the 401(k) plan was adopted, a competent consulting firm would have worked with the employer to make SURE that the plan  accurately reflected the desire by making sure the plan is properly designed from the beginning.

So, the question is: what was done about this when the plan was adopted? Was a professional, competent firm involved in advising the client, and if not, why not?  You are looking for answers now as to what the plan document that was adopted calls for, and we have no idea since we don't have a copy of the document, but more important is that the plan should have been set up to correctly reflect the employer objectives, and if that wasn't done, that is the mistake that needs to be fixed.

And it almost definitely can still be fixed at this date; are you working with a competent admin firm?  If not, that is what you need to do.  

[BrownTrout]

17 hours ago, Bird said:

You are on the right track.  I won't answer your specific questions because the correct approach, at least the way we would do it, is to have the sole prop be an adopting employer.  All service would count and contributions for the year would come from both entities.  

Thanks!

[BrownTrout]

13 hours ago, Larry Starr said:

As if often the case, the wrong questions are being asked. Instead, the questions asked should be "what does the client want to do" with regard to the time it was a sole prop.  Normally, the sole prop (which is still in existence; it NEVER goes away legally until the sole prop dies) would adopt the plan and all predecessor activity would count.

When the 401(k) plan was adopted, a competent consulting firm would have worked with the employer to make SURE that the plan  accurately reflected the desire by making sure the plan is properly designed from the beginning.

So, the question is: what was done about this when the plan was adopted? Was a professional, competent firm involved in advising the client, and if not, why not?  You are looking for answers now as to what the plan document that was adopted calls for, and we have no idea since we don't have a copy of the document, but more important is that the plan should have been set up to correctly reflect the employer objectives, and if that wasn't done, that is the mistake that needs to be fixed.

And it almost definitely can still be fixed at this date; are you working with a competent admin firm?  If not, that is what you need to do.  

Thanks Larry. The plan has not yet been adopted and my never be adopted. The client doesn't yet have a plan and says he doesn't want to put one in place until after the entity change (not sure why...been trying to convince him that it makes sense to do so now). Just trying to get my ducks in a row since I'm sure I won't hear about the entity change until after it happens ? 

The client will definitely want to include prior service and the portion of comp that's earned in the sole proprietorship so sounds like the S-Corp will adopt the new plan (when that time comes) but the sole proprietorship will need to also sign on as a participating employer.

I appreciate the feedback!

[Larry Starr]

Glad we could help. But if you post in the future, PLEASE include the actual situation which you kept secret until your response posting. Makes it much easier to respond with answers that you could really apply to your situation. What we do is very fact specific and the more we have the real facts, the better the responses will be to your situation.