Unbeknownst SEP-IRA by affiliated service group member

[J Simmons]

Happy holidays!

The situation I am posting about involves a professional practice that is composed of an LLC that employees the staff and separate S-corporations, one each for the professionals who also collectively own the staff LLC. The staff LLC has a safe harbor 401k; in addition to a 3%-of-pay safe harbor contribution, the LLC pops in another 2%, establishing a 5% gateway minimum for cross-testing.  Each of the professionals' S-corporations has an identically drawn up 401k plan that permissively aggreates with the staff LLC's 401k, to allow the S-corporation to make a cross-testing determined contribution to its plan for its only employee, the professional that owns the S-corporation. 

One of the new professionals did not coordinate into this situation, but was convinced by an investment adviser to have her S-corporation instead set up a SEP-IRA to which she then make contribution for 2020 and 2021.  We're hoping to get the 2021 contribution, and investment earnings, paid out to the S corporation (and hopefully the financial institution won't report either the 2021 contribution nor its return to her. If so, her S corporation will simply include that amount in its taxable income for 2021).

2020 might not be so easy.  Because of the affiliated service group rules, the staff LLC employees would be included as benefiting employees in that professional's S-corporation's SEP-IRA.  If the contribution for the professional was say, 8%, of her 2020 W-2 wages from her S Corporation.  There might be a contribution due from the staff LLC to that SEP-IRA of 8% of their pay.

I am hoping that we can simply undo the 2020 contribution, have the financial institution regurgitate the 2020 contribution, the S-corporation and professional amend the 2020 Forms 1120-S, W-2 and 1040 to reflect the additional income.  Is that possible?

If it is not, rather than 8% for all the staff LLC employees having to be contributed, can the dollars that make up that 8% be re-allocated among that professional and all staff in proportion to their considered compensations?

 

[shERPA]

Well the SEP failed to meet the coverage requirements, so it's not deductible.  Not being an ERISA plan I don't know that the employees have any claim for benefits.  There is no provision for any offset between qualified plans and SEPs, maybe something could be negotiated with the IRS.  In my experience clients and their advisors tend to let sleeping SEPs lie.  Seems like a good time to repost this, I wrote it years ago (back when the 415 limit was $40K):

Ode to SEPs
 
At the ripe old age of 42,
My CPA said this won't do, 
He told me I'm out of step,
To cut my taxes, go start a SEP.
 
Sent me to a TPA, he said Yep
A SEP might work, but first let's see.
Lo and behold, we have an ASG!
 
He told me we could work around the ASG;
But there would be attorneys fees,
Determination letters and trustees,
Not only that, I'd have to contribute for employees!
 
But, wait, I have no employees, they work for XYZ,
But the lawyer said the ASG 
Means those employees work for me!
We'll design a plan, that will conform,
Of course you'll have to file the 5500 form.
 
I said OK, let's kill some trees, 
But before we do, please explain the fees.
When he was done, I had to pee,
Surely I could find simplicity.
 
So I went online to explore
Found SEPs, 401(k)s, and more,
They needed my name and address and EIN
But had no pesky questions about 414(b), (c) or (m).
 
What about the IRS, would they find my SEP?
They audited my return, said I did misstep,
About my SEP they did not complain, 
But disallowed my green fees, oh the pain!
 
My SEP grew and grew and I paid no fees
Wrote a check every year for my 40 Gs.
As for my employees, they did not know,
For their retirement, they have nothing to show.
 

[cathyw]

About 10 years ago an accountant referred an S-corp client under audit to me.  The IRS was questioning SEP contributions that had been made for several years for the owner only (the owner claims that the financial advisor who set up the SEP told her she would be the only one eligible for the SEP -- ha, ha).  The SEP had assets of about $500,000 at that point. The owner couldn't afford to make proportionate contributions for the staff for all the years under audit.  We acknowledged to the IRS that the SEP was defective and negotiated to treat the contributions to the underlying IRA for the open years as compensation to the owner, thereby retaining the deductions to the S-corp.  The IRS did not disqualify the owner's IRA, leaving the $500,000 as tax deferred.  We then set up a 401(k) profit sharing plan for the company and they've been a client ever since (plus now they also sponsor a cash balance plan).

That was the only time I ever heard of a SEP being audited.

 

[Appleby]

On 12/30/2021 at 6:03 PM, shERPA said:

Ode to SEPs
 
At the ripe old age of 42,
My CPA said this won't do, 
He told me I'm out of step,
To cut my taxes, go start a SEP.
 
Sent me to a TPA, he said Yep
A SEP might work, but first let's see.
Lo and behold, we have an ASG!
 
He told me we could work around the ASG;
But there would be attorneys fees,
Determination letters and trustees,
Not only that, I'd have to contribute for employees!
 
But, wait, I have no employees, they work for XYZ,
But the lawyer said the ASG 
Means those employees work for me!
We'll design a plan, that will conform,
Of course you'll have to file the 5500 form.
 
I said OK, let's kill some trees, 
But before we do, please explain the fees.
When he was done, I had to pee,
Surely I could find simplicity.
 
So I went online to explore
Found SEPs, 401(k)s, and more,
They needed my name and address and EIN
But had no pesky questions about 414(b), (c) or (m).
 
What about the IRS, would they find my SEP?
They audited my return, said I did misstep,
About my SEP they did not complain, 
But disallowed my green fees, oh the pain!
 
My SEP grew and grew and I paid no fees
Wrote a check every year for my 40 Gs.
As for my employees, they did not know,
For their retirement, they have nothing to show.

Brilliant!

[Bri]

I'm imagining Derrin Watson singing that as lyrics - got a melody for it?

[shERPA]

1 hour ago, Bri said:

I'm imagining Derrin Watson singing that as lyrics - got a melody for it?

No, I'm not nearly as creative or talented as Derrin.  This came to me in a fit of inspiration after yet another prospect objecting to the plan design I was presenting by asking "why would I cover all these employees when I can do a SEP for myself?".   But as for musical abilities I have pretty much zero.   Have at it!