Removal of DC contribution in excess of 6%

[truphao]

A client (sole-proprietorship, one person, income way over IRS comp limit) has decided to install a CB plan for 2023.  Unfortunately, he has already  fully funded his "solo 401(k)" plan at full $66,000.  So now he has to remove the excess of $23,700 (plus earnings).   His "solo 401(k)" is with one of the Big 3 (Schwab, Fidelity, Vanguagrd) using their simplified "solo 401(k)" documents which does not allow for "voluntary after-tax" nor for in-plan Roth conversion.   Is the following approach available (all done before December 31st):

1) Restate his plan using the customized plan document which will allow for VAT and In-Plan Roth conversion

2) Treat the excess of $23,700 as after-tax deposit

3) Do In-Plan Roth conversion of $23,700 (plus earnings)

Normally, I would say no on account of timing of the deposit being made before the provision is in the document.  However, I am wondering if the sole-proprietorship nature of the business changes the answer since all the compensation is deemed to be earned on December 31st?

[Bird]

You can (generally) retroactively add provisions to a document after they are used but before the end of the year. We did exactly (or close to it) this for someone a couple of years ago. There might be a bit of an issue of them being "designated" as employer when they were contributed (and that was obviously the intent, but with a sole proprietor, there is never (?) any paperwork to codify this) but...yeah, I say go for it; good thinking.

[david rigby]

Presumably, this sole proprietor is creating a DB plan to target the 415-maximum benefit.  Is that correct?  It's not clear to me why such plan would be a cash balance plan.  Seems that a traditional DB plan design would be more appropriate.  But maybe it's just me.

[truphao]

David, this is just my personal preference on account of 2 items: 

1) CB Plans are much easier to explain

2) More flexibility (IMHO) to control the costs should the income change

Both might be more of a perception rather than a reality.  I appreciate the feedback as always.

[Hojo]

I've hit the runaway train scenario with traditional DB Sole-Props too often when income was huge and later fallen off the cliff.

[CuseFan]

If you can somehow get those excess PS reclassified, maybe you're OK, but I would not tell anyone that I think such strategy would hold up under audit. I'd say we can try but you're playing audit roulette for three years on this, at least that's my opinion. 

In these cases, I'll usually present limiting total deduction to the 31% and then carry forward remaining CB deduction to the next year properly limiting the PS to 6%. Depending on CB contribution and deduction funding cushion, sometimes it even takes a second year to catch up.

This just follows the fact pattern, I don't see a legitimate basis for being able to reclassify a contribution that was made as a deductible profit sharing contribution as something different - and certainly not as VAT contribution when no such designation was made when contributed.

[Bird]

1 hour ago, CuseFan said:

If you can somehow get those excess PS reclassified, maybe you're OK, but I would not tell anyone that I think such strategy would hold up under audit. I'd say we can try but you're playing audit roulette for three years on this, at least that's my opinion. 

In these cases, I'll usually present limiting total deduction to the 31% and then carry forward remaining CB deduction to the next year properly limiting the PS to 6%. Depending on CB contribution and deduction funding cushion, sometimes it even takes a second year to catch up.

These are good points. I didn't mean to be too cavalier about the approach; it does require a caveat. And we would typically take the approach of limiting the deduction to 31% and catching up in future years.