First Year Top-Heavy Question

[effingeh]

Hello! We have a client that started their plan in 2022 and failed ADP and TH testing due to their owner maxing out their contribution. Their TH Funding was going to be almost $30k and they demanded a reversal of all the owner's contributions in 2022 which were processed recently after many conversations on why this was a bad idea and having them approve a hold harmless letter. Several questions about this:

1 - Does the reversal change the TH test? The balance as of 12/31/22 hasn't changed, and I know first-year plans can use accrual, but I have only ever used that when adding employer contributions to the total. Was not sure how this should/could be handled since I have never had a client actually go through with a request like this.

2 - Similarly, the Form 5500 will reflect the amounts that were in there on 12/31/22 since this is done on a cash basis. So do their quarterly statements. Should any of this be updated or should it all be left as-is? It's just a glaring issue in an audit and I am fine with that as the client signed off understanding they need to own everything that comes with the request.

3 - The reversal that was processed was for exactly $20,500 and all earnings/dividends remained in the plan. Thoughts on how this should be handled? Their letter of direction stated the exact amount versus making it all look like it never happened but, again, such an obvious issue if looked into.

Thanks!

[justanotheradmin]

What is your relationship to the plan?

Are you the TPA? Advisor? Do you provide recordkeeping services? Was your office the one that processed the reversal?

Honestly at this point I'd probably resign. The client should have been told about ADP and TH testing (perhaps they were and it just didn't register) and if they are committed to doing it correctly (they can't even bother to take out earnings correctly?) which the money never should have been removed its an issue.

and FYI 5500 are often on accrual basis. The schedules even have lines specifically asking about receivables and liabilities. 

[effingeh]

We provide recordkeeping services. Our legal team spoke with the client about all of this and chose not to listen to the advice given which is where the hold harmless came in. All testing was covered during onboarding. We have recorded calls for all of the above. I personally received a request to assist in updating their testing to reflect $0 contributions by the owner and, since I have never seen a client do this in all my years, I wanted to get other opinions on how to look at this.

As for the issue with earnings/dividends, I don't think the team that handled this had a process in place for such a request. It wasn't a typical ROE where all of that would have been calculated but it was one of the first things that stood out to me. Personally, I would have pressed for a first-year QNEC of about $7k that would have helped them pass 2022 and 2023 TH testing. At this point I am looking for options before preparing any 'updated' testing since I am split on how it should look.

I am also aware of 5500s being done on accrual but this company has taken the stance that they will all be done on a cash basis.

[Lou S.]

I'm not a lawyer, but it sounds like fraud. I wouldn't touch it.

[Paul I]

I take it that it was the client that decided not to listen to the advice given by the legal team, and not the case of the legal team not listening to your advice.  I am surprised that the legal team believes that a hold harmless agreement provides your firm sufficient protection.  I cannot imagine this agreement would protect your firm from involvement should the participants (or the DOL or IRS) sue the plan to get them their top-heavy contribution.  But, like Lou, I am not a lawyer.

Some things are clear.  The plan cannot avoid being top-heavy by refunding contributions to key employees.  The IRS will not recognize this as a cure and likely, if discovered, will tell the company to make the top-heavy contribution or have the plan disqualified for not following the terms of the plan.

Leaving the earnings on the deferrals in the plan is a bizarre decision.  The earnings do belong in the plan, as do the contributions.  If the company wanted to make this look like a correction, it failed.  All correction methods require the earnings to be taken out of plan alongside any refunds of excess amounts.  This only highlights the company's disregard for compliance.

If you or others in your firm hold almost any professional designations or belong to professional organizations (e.g., CPA, EA, ERPA, QPA, QKA, ... or AICPA, ASPPA, NAPA, PSCA, ...), you are subject to a code of professional ethics.  I strongly suspect that your professional credentials and membership are at risk for not only following the company's direction but also preparing replacement documentation that masks the facts.  It would be interesting to hear from others on BL their opinion on the application of professional ethics codes in this situation.

And now for the really tough decision.  On a personal note, I would not prepare or put my name a test showing a $0 contribution for the owner.  I also would not falsify any information on a 5500.  If your employer or the legal team believes these actions are acceptable, then let them prepare and put their name on it (and you can take comfort that you can find work, including remote work, at a reputable firm within a week).

This is not advice, and is somewhat overly dramatic, but there are some realities here that cannot be ignored.  May you be at peace with whatever is your decision on how to respond this situation.

[msmith]

I agree 100% with Paul I. Not willing to risk my credentials for outright fraud. Ethics is a big factor in how this is reconciled.