Owner Comp Mid-year Plan Termination

[BG5150]

Sole prop plan.  Plan terminated 6/30/20.  Profit Sharing only.  Owner wants to make a contribution for the year.

How do I determine the owner's comp?  Sched C won't be ready until next year.

What if it's not PS only, but a 3% SH, or a plan with a fixed match?  Do I have to wait until late-winter or spring? 

[Bird]

I think most folks, myself included, would say he has no comp on 6/30 and therefore no contributions of any kind allowed.  It's effectively all earned on 12/31.  

[Larry Starr]

10 hours ago, BG5150 said:

Sole prop plan.  Plan terminated 6/30/20.  Profit Sharing only.  Owner wants to make a contribution for the year.

How do I determine the owner's comp?  Sched C won't be ready until next year.

What if it's not PS only, but a 3% SH, or a plan with a fixed match?  Do I have to wait until late-winter or spring? 

Mistake was to terminate plan as of 6/30.  As others noted, that means he has ZERO compensation for the short plan year.  Consider rescinding the termination and re-terminating as of 12/31 if getting a contribution for this year is important enough to the parties.

[Luke Bailey]

1 hour ago, Larry Starr said:

Consider rescinding the termination and re-terminating as of 12/31 of getting a contribution for this year is important enough to the parties.

Maybe achieve the same result through a sole proprietor "written resolution" to make a contribution for 2020 based on comp through 6/30 (2020 comp divided by 2 for sole proprietor)? You would still need to keep the trust intact until contribution made.

[Bri]

I suppose a possible issue there would be not knowing if you passed 401a4 until the Schedule C was ready, and then you might have to allocate more to the staff after they'd already cleared out their balances.

[Larry Starr]

5 hours ago, Luke Bailey said:

Maybe achieve the same result through a sole proprietor "written resolution" to make a contribution for 2020 based on comp through 6/30 (2020 comp divided by 2 for sole proprietor)? You would still need to keep the trust intact until contribution made.

I don't believe that is possible.  Legally, there is NO COMP through 6/30.  A sole prop is considered as earning 100% of his comp on the last day of his taxable year (12/31 almost always).  A simple new amendment that both rescinds the prior termination date and adds a new one of 12/31 would take care of the problem quite easily.

[Larry Starr]

4 hours ago, Bri said:

I suppose a possible issue there would be not knowing if you passed 401a4 until the Schedule C was ready, and then you might have to allocate more to the staff after they'd already cleared out their balances.

Assuming facts not in evidence. He never said that there were any employees other than the sole prop.  

[david rigby]

13 hours ago, Larry Starr said:

He never said ...

True, but many posts on these Boards have omitted key information relevant to the question.  Sometimes it helps to ask, rather than assume.

[BG5150]

Sorry.  There ARE other employees.  Probably 5 or 6.

Other things of note:  company ceased day-to-day operation on 6/30, and no longer has employees.

Maybe do a 5% contribution to EEs and then see what the owner can get after Sched C is available?

This way Employees can take distributions.

[Alonzo Church]

First -- employees should be able to get distribution because they terminated employment.

Second -- Change the definition of the contribution to something approximating actual compensation that won't be discriminatory. (Base it on the greater of 50% of PY base compensation, or comp accrued as of 6-30, for example)

If you end up violating 415 on the owner-employee, immediately refund the money at year end. Trust has to survive until 12-31.

[BG5150]

'Zo:

I know they can take a distribution now (kinda--its a pooled account and I have to do my valuation), but I'd rather wait a week or two and have the contribution deposited so they only have to take one distribution.

I figured we could allocate 5% to the staff (I know their plan year comp already).  I will have to look to see if there is a last day rule and do 11-g if there is.

Then we can do distributions to the staff.  Then, wait until the Sched C done and allocate as much as I can to the owner whilst still passing testing.

[Alonzo Church]

Don't wait until 12-31 to do the contribution. Have your nondiscrimnatory amount calculated and your plan doc changed before 12-31.

[BG5150]

2 hours ago, Alonzo Church said:

Second -- Change the definition of the contribution to something approximating actual compensation that won't be discriminatory. (Base it on the greater of 50% of PY base compensation, or comp accrued as of 6-30, for example)

 

Even if I made the formula based on PY comp, I still have to test using the comp from the current year.

 

[Luke Bailey]

22 hours ago, Larry Starr said:

I don't believe that is possible.  Legally, there is NO COMP through 6/30.  A sole prop is considered as earning 100% of his comp on the last day of his taxable year (12/31 almost always).  A simple new amendment that both rescinds the prior termination date and adds a new one of 12/31 would take care of the problem quite easily.

Larry, I think we may be saying sort of the same thing. The business will have a full year. I'm just saying half of the full year comp is what he or she earned through June 30. Company would resolve now to contribute X% of that to the "terminated" plan's trust, just like they could have resolved next year to contribute X% of 2020 comp. Just trying to make it simple.

[Bird]

Back up.  If you want the owner to get anything, you have to un-terminate the plan.  Period.  There is no comp at 6/30.  If you are going to wait until after 12/31 to determine that comp, and then (improperly) use half of it, why not just un-terminate and wait for the full year's comp?

Term'd employees may or may not be entitled to distributions immediately after employment; our plans would typically say they have to wait until after the end of the year (of course that could be amended but don't disregard the terms of the document).

Assuming the plan allows for immediate distributions, you do not have to wait until the contribution is deposited; you just need to know what it is (as long as there is sufficient cash...and as soon as the possibility of plan termination comes up, we would discuss moving everything to cash).  

[imchipbrown]

Contribution for owner (what, 5%?) can't be enough to make the easy termination this complicated.  Just pay the taxes and move on.  My 2¢

[Larry Starr]

On 7/24/2020 at 7:38 PM, Luke Bailey said:

Larry, I think we may be saying sort of the same thing. The business will have a full year. I'm just saying half of the full year comp is what he or she earned through June 30. Company would resolve now to contribute X% of that to the "terminated" plan's trust, just like they could have resolved next year to contribute X% of 2020 comp. Just trying to make it simple.

Luke, no we are not saying the same thing.  Half of zero is zero.  At June 30 the earnings for a SE individual is ZERO; he or she hasn't earned ANYTHIING! 100% of the money is earned on the last day of the year.

[Larry Starr]

On 7/24/2020 at 10:27 AM, BG5150 said:

Sorry.  There ARE other employees.  Probably 5 or 6.

Other things of note:  company ceased day-to-day operation on 6/30, and no longer has employees.

Maybe do a 5% contribution to EEs and then see what the owner can get after Sched C is available?

This way Employees can take distributions.

Always nice to have complete information at the beginning to answer questions appropriately. Anyway, go back and review my prior answers: nothing changes.  And yes, you will have to do non-discrim testing if you change the termination date to end of year.

[Luke Bailey]

14 minutes ago, Larry Starr said:

Luke, no we are not saying the same thing.  Half of zero is zero.  At June 30 the earnings for a SE individual is ZERO; he or she hasn't earned ANYTHIING! 100% of the money is earned on the last day of the year.

Wow, Larry, do you have a cite for that? Let's change the example a bit. Suppose I have a 5% money purchase pension plan, calendar year, and I freeze it as of June 30 and say that I'm not terminating yet, just freezing. Employees get 5% of their W-2 comp through June 30. Suppose the business is profitable and the owner has $200k of SE income for the full calendar year. You're saying the owner can't get $5,000 contribution for the year?

[Bird]

15 hours ago, Luke Bailey said:

Suppose I have a 5% money purchase pension plan, calendar year, and I freeze it as of June 30 and say that I'm not terminating yet, just freezing. Employees get 5% of their W-2 comp through June 30. Suppose the business is profitable and the owner has $200k of SE income for the full calendar year. You're saying the owner can't get $5,000 contribution for the year?

Larry of course can speak for himself but that is correct.  Of course I probably learned my position from him 30 odd years ago but I have no doubt it is accurate.

[Bird]

22 hours ago, imchipbrown said:

Contribution for owner (what, 5%?) can't be enough to make the easy termination this complicated.  Just pay the taxes and move on.  My 2¢

If you are saying that given the facts (plan term'd 6/30) the owner gets no contribution, then I agree.  It is black and white simple:  leave term date 6/30 and the owner gets nothing and you can distribute when feasible, before the end of the year.  If the owner wants to get something then the plan has to be un-term'd and wait til after year-end to determine his/her comp.  Everyone is entitled to their own opinion but not their own facts.

[Luke Bailey]

2 hours ago, Bird said:

Of course I probably learned my position from him 30 odd years ago but I have no doubt it is accurate.

Loyalty at that level is inspiring in a way, but I'd still like the citation!

[Belgarath]

I'm not sure there is a direct citation one way or the other. You can perhaps glean a bit of "sideways" information on the general IRS thought process by looking at 1.401(k)-1(a)(6), and 1.401(k)-2(a)(4)(ii), but I wouldn't classify those as definitive for purposes of a profit sharing deduction in this situation. I will say that general industry practice, (in my experience) and the CPA's I've worked with, have taken the approach that it is earned on the last day of the tax year. I'm not saying you can't make an argument for prorating, (whether you'd win or not on audit is debatable) but why would you want to take the aggressive approach in a situation such as this, which can so easily be fixed as previously proposed by several people? 

[Luke Bailey]

1 hour ago, Belgarath said:

1.401(k)-1(a)(6), and 1.401(k)-2(a)(4)(ii

Belgarath, I have always viewed these as rules of convenience that enable partners to contribute to K plans, e.g. with last day of year election.

 

1 hour ago, Belgarath said:

I'm not saying you can't make an argument for prorating

Agreed.

[Bird]

I just talked to an accountant about this and he's of the opinion that it is earned ratably over the year (otherwise why would you have to make estimated quarterly payments?).  That is contrary to what I said above (vehemently!) and I'm not conceding but I thought it fair to share. 

I do think we all agree that you can't estimate half year's comp before the year is over...which makes the discussion rather pointless - why on earth, if you have to wait until after the end of the year to determine half of the year's comp, not just use the full year's comp?  (Other than to avoid the embarrassment of admitting it was wrong to terminate on June 30.)

[BG5150]

UPDATE:  Plan doc was wrong.  Entity is a P.C. and the owner does get paid on a W2!  Company changed structure a few years ago and no one thought to update the plan doc.

So, I guess this discussion doesn't apply to me any more.

However, I think we had a good, robust discussion.

[Larry Starr]

On 7/28/2020 at 9:39 AM, Bird said:

Larry of course can speak for himself but that is correct.  Of course I probably learned my position from him 30 odd years ago but I have no doubt it is accurate.

BLUSH!

[Larry Starr]

7 hours ago, Bird said:

I just talked to an accountant about this and he's of the opinion that it is earned ratably over the year (otherwise why would you have to make estimated quarterly payments?).  That is contrary to what I said above (vehemently!) and I'm not conceding but I thought it fair to share. 

I do think we all agree that you can't estimate half year's comp before the year is over...which makes the discussion rather pointless - why on earth, if you have to wait until after the end of the year to determine half of the year's comp, not just use the full year's comp?  (Other than to avoid the embarrassment of admitting it was wrong to terminate on June 30.)

I should point out that there are differences of opinion; you know mine.  I should note that Derrin does not agree; he believes that the Schedule C can be treated as earned ratably over the year. The fact of the matter is that there are no regs or cites that specifies either position as the correct one, but of course mine is the correct one!?

The argument about  estimated quarterly payments doesn't hold up for me; the government wants it's money during the year, based on an ESTIMATE of what might be the total income for the year, and there are lots of rules if you are off substantially with regard to underpayment. But the key is the it is ESTIMATED taxes, which is not based on ACTUAL earnings, so I don't think that argument is on point.