Chicken vs. Egg and 415 Limits

[Towanda]

A 401(k) Safe Harbor Plan was terminated effective March 15, 2019.

In December 2019 the owner deposited $19,000 as salary deferrals into the plan.  She earns W-2 income, and those deferrals were reported on her 2019 W-2.

Because of the short plan year, and because the plan was not terminated as the result of economic loss or an acquisition, the plan lost its Safe Harbor status for the short plan year.  Further, the owner was the only employee who contributed salary deferrals to the Plan in 2019.

The owner would like to make a Profit Sharing contribution to the extent possible.

415 limit for 2019 is pro-rated to $11,666.67.

This whole series of events is scrambling my brain.

1.  Can we deposit $11,666.67 as Profit Sharing and treat the $19,000 in deferrals as an Excess Annual Addition?  In other words, moving her out of ADP test failure/Form 5330 territory into 415 violation territory, OR

2.  By virtue of having made the salary deferral contributions, is she no longer able to even consider a Profit Sharing contribution for 2019 because a 415 violation already exists?

3.  And if we go with 2., do we split her $19,000 refund into two pieces:  1) ADP test failure refund of $11,666.67 and prepare Form 5330, and 2) treat $7,333.33 as a 415 excess to be refunded?

Although I know there are other sticky issues going on here, my primary concerns for the moment are the questions I've posted above.

Thank you!

[Lou S.]

When were the deferrals withheld?

If they were withheld after 3/15 termination you have a problem of ineligible deferrals. If they were withheld before 3/15 but deposited in December you have late deferrals.

As an HCE, even if they are refunded under 415 or ADP they are still considered annual additions for the Plan Year and they are also included in the ADP test, but you don't need to refund them twice.

What did the termination amendment say about the limitation year?

[Towanda]

The owner has historically made a single deposit at the end of each calendar year, just in the nick of time.  I wouldn't necessarily lean in the "late deferral" direction on this one. 

The limitation year isn't mentioned in the termination amendment.  Only that the plan is terminated effective March 15, 2019, and no further contributions to be made under the Plan for compensation earned after March 15, 2019.

If they are treated as ineligible deferrals, now we're moving into stickier territory.  Does that mean the deferrals are returned (with applicable earnings) and her W-2 is amended . . . or do we issue a 1099-R with a code ____ ?????

 

[BG5150]

The question to start with is:  from which paycheck(s) were the deferrals taken?

If before 3/15, then the deposit is most definitely late.  If after, they are not valid deferrals, because the plan was terminated.  Was anyone else allowed to defer after that date?

(This may warrant looking into past years, too.  Does the owner really just get one big paycheck at the end of the year for the deferrals?  Or did he get paychecks throughout the year and he just deposited the deferrals at the end of the year?  Did those deferrals really get taken from each of the paychecks?  Or was the W2 "corrected" to show the deferral at the end of the year?)

[Towanda]

The owner is not on payroll per se.  I receive a payroll report at the end of the year and the owner's W-2 because she is not on the payroll report.  Her 401(k) deposit is always made in December, so my guess is that she works with her CPA to handle her withholding, etc. separately, and she makes her deposit in one shot every December so that it can be reported on her W-2. 

Her employees have never contributed to the plan. 

 

[Lou S.]

Sounds like you need to talk to your client and get some more facts.

Is this Plan top-heavy?

Were all the employees terminated or did the Plan just terminate.

If you do make PS wont that go to employees too? It sounds like she's the only HCE so I'm assuming you'd have a testing failure if shes the only one getting PS.

[Towanda]

The plan is most definitely Top Heavy, and only the plan was terminated.  The business is continuing.

Absolutely, the employees would receive a Profit Sharing contribution . . . but that's only if the owner's deferrals are considered an Annual Addition . . . which it sounds like they may not be if the deferrals were ineligible. 

Getting "facts" is a near impossibility with this client by the way.  She's a slippery one, and that's a whole 'nother story . . .

[Larry Starr]

55 minutes ago, Towanda said:

The plan is most definitely Top Heavy, and only the plan was terminated.  The business is continuing.

Absolutely, the employees would receive a Profit Sharing contribution . . . but that's only if the owner's deferrals are considered an Annual Addition . . . which it sounds like they may not be if the deferrals were ineligible. 

Getting "facts" is a near impossibility with this client by the way.  She's a slippery one, and that's a whole 'nother story . . .

Time to walk away from this client; we don't allow "slippery" clients and we demand the facts.  Otherwise, find someone else to be your advisor. NEVER LIE TO US either; that's a sure way to get fired.  Now, I question why anyone would terminate this plan mid year instead of as of year end, but that's a whole other thread of discussion that I have no desire to get into with the facts of this situation.

[Towanda]

Precisely Larry . . . this Plan has been excruciating from the get-go, and it's going to end its life kicking and screaming to the bitter end.  Groan.

 

[Lou S.]

Refund 100% of the deferral as failed ADP, prepare 5330 for the late refund, calculate a 3% TH minimum for the employees who were employed on date of termination.

Move on.

[Towanda]

Thank you Lou!

 

 

[Belgarath]

FWIW, you do have a short limitation year if the plan is terminated on a date other than the last day of the plan's limitation year.  1.415(j)-1(d)(3).