SECURE 2.0 317: Retroactive 1st year deferral for Sole Prop

[joef]

Under SECURE 2.0 section 317, a Sole-Prop can RETROACTIVELY elect to defer for a new startup 401k for PYs beginning after 12/29/22. Normally I would think that means “for 2023 PYs”, but could the following work:

1. Initial SHORT PY = 12/30/22 – 12/31/22
2. Limitation Year = calendar year ending within PY
3. Compensation Computation Period = calendar year ending within PY
4. Therefore elect to defer full 20.5K/27K for 2022 PY fully deductible for 2022 Tax return.
5. (+ PS alloc up to 415 limit, which is NOT prorated since Limitation Year is full 12 months, as well as Comp year; this part was already available for retroactively adopted plans I believe)

I’m a pension actuary obviously trying to think outside the box and there may be other boundaries that can’t be crossed that I am not thinking of. 401ks are not my forte.

[truphao]

Love your thinking Joef, IRS does not have a chance against talented actuaries long term.

The only issue I am thinking about is the income.  I think you would have to demonstrate that so much income was earned between 12/29 and 12/31 to process the valid 401(k) deferral? 

[joef]

Thanks Truphao.

My understanding is that Sole-Props have always been able to adopt a 401k on 12/31/YY and immediately make their "election" (for up to max deferral), subject to the finalized calculation of their limits based on finalized calc of Considered Compensation (which may actually happen as of 10/15/YY+1). I think the reasoning is that their income is not established until 12/31/YY, and even then subject to many computations that take place after that date. I'll leave it to the forum to either confirm, clarify, or correct my understanding and explanation on that point! Anyway, on that basis, I think the principle would be the same for the proposed SHORT PY--with the compensation period duly defined as above.

One additional thought in support of my original proposal: it appears the intent of congress was to make this provision available ASAP because they explicitly made the effective date "after 12/29/22"; if they wanted the impact of of the section delayed to 2023 PYs they could easily have made the effective date "after 12/31/22". However, code writers are clearly not practitioners, so it didn't occur to them that it might present a challenge to implement the new rule for 2022 Plan Years. 

[Jakyasar]

Out of curiosity, don't you have short plan year limitations? Not sure if you can have a short plan year with full limitation year. Curious what others will say.

I agree that it is badly written with the enactment date of the law.

[truphao]

limitations are based on the tax/plan year if the plan doc is written properly.  My concern is ability to defer 401(k) elective wrt comp earned before plan is effective.   I am very interested what others have to say.

[joef]

I've already checked the Datair Standardized AA and Base Doc and these permit the election of the Limitation Year and the Compensation Computation Period as I specified in #2 and #3 above without considering Short/12 month PY. So that seems favorable.

Also, these 2 IRS bulletins have relevant discussion on both compensation and 415 limits for Short PYs:

• https://www.irs.gov/retirement-plans/issue-snapshot-treatment-of-401a17-limitation-in-defined-contribution-plan-in-a-short-plan-year
• https://www.irs.gov/retirement-plans/issue-snapshot-treatment-of-415c-dollar-limitations-in-a-short-limitation-year

[Jakyasar]

Joef

I am aware of the sections but on the proration limit for salary, you can use example 2 but not example 3 as the law says for plan years beginning on or after 12/29/2022. Unless one designs fiscal plan, you can only have a 3 day plan here for a calendar plan approach.

Your prior statement of a sole prop's income is determined as of 12/31/2022 for a full year. But is this case here?

There is a very big difference if the full year income is 500k vs 1k in the last 3 days, very valid concern. Of course, on a worst-case scenario, simply set up a PS plan, you will only lose the catch-up, if eligible.

I am aware that you can make a limitation year a full year even if you have a 1 day plan year but I am curious if they allow it with this new rule. I doubt they would take it away but...

Just thinking/worrying about loud. Time to watch bad movies.

[Peter Gulia]

Even if the plan year began December 30, 2022 and ended December 31, 2022, might the limitation year have been January 1, 2022 to December 31, 2022?

“Unless the terms of a plan provide otherwise, the limitation year, with respect to any qualified plan maintained by the employer, is the calendar year.” 26 C.F.R. § 1.415(j)-1(a) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.415(j)-1#p-1.415(j)-1(a).

Even if both the plan year and the limitation year were December 30-31, 2022, might a sole proprietor’s § 401(c)(2) earned income for 2022 have been earned on December 31, 2022?

“[A] sole proprietor’s compensation is deemed currently available on the last day of the individual’s taxable year[.]” 26 C.F.R. § 1.401(k)-1(a)(6)(iii) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401(k)-1#p-1.401(k)-1(a)(6)(iii).

[truphao]

Peter, Thank you so much!  Am I reading this correctly that we got another hyper-aggro design in place to squeeze few bucks away from IRS?

[Peter Gulia]

I suggest only some points of authority a professional might consider, along with other authorities, to construct a reasoned interpretation.

A taxpayer should want her professional’s advice about whether an interpretation has enough authority for a tax-return position.

See 26 C.F.R. § 1.6662-4(d) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR1d0453abf9d86e0/section-1.6662-4#p-1.6662-4(d).

I ask some questions; but a professional must do the complete research, analyze and interpret all possibly relevant authorities, and render careful advice.

[Jakyasar]

7 hours ago, Peter Gulia said:

Even if the plan year began December 30, 2022 and ended December 31, 2022, might the limitation year have been January 1, 2022 to December 31, 2022?

“Unless the terms of a plan provide otherwise, the limitation year, with respect to any qualified plan maintained by the employer, is the calendar year.” 26 C.F.R. § 1.415(j)-1(a) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.415(j)-1#p-1.415(j)-1(a).

Even if both the plan year and the limitation year were December 30-31, 2022, might a sole proprietor’s § 401(c)(2) earned income for 2022 have been earned on December 31, 2022?

“[A] sole proprietor’s compensation is deemed currently available on the last day of the individual’s taxable year[.]” 26 C.F.R. § 1.401(k)-1(a)(6)(iii) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401(k)-1#p-1.401(k)-1(a)(6)(iii).

Totally agree but being cynical, let's see what and if they will come up with.

Thank you

[joef]

On 1/22/2023 at 7:20 AM, Peter Gulia said:

Even if the plan year began December 30, 2022 and ended December 31, 2022, might the limitation year have been January 1, 2022 to December 31, 2022?

“Unless the terms of a plan provide otherwise, the limitation year, with respect to any qualified plan maintained by the employer, is the calendar year.” 26 C.F.R. § 1.415(j)-1(a) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.415(j)-1#p-1.415(j)-1(a).

Even if both the plan year and the limitation year were December 30-31, 2022, might a sole proprietor’s § 401(c)(2) earned income for 2022 have been earned on December 31, 2022?

“[A] sole proprietor’s compensation is deemed currently available on the last day of the individual’s taxable year[.]” 26 C.F.R. § 1.401(k)-1(a)(6)(iii) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401(k)-1#p-1.401(k)-1(a)(6)(iii).

Peter, thank you for the insightful citations!

Joe F