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SIMPLE IRA contributions made not using payroll


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Hello. I have a situation where an S Corporation sole shareholder set up a SIMPLE IRA plan for himself and his three employees in April, 2022 using his financial broker. In 2022, he deposited 14,000 for himself into this plan with money from his savings account. There was no payroll withholding for this plan for the owner or his employees. He never notified payroll he even had this plan. He was funding this plan through his financial advisor, who I recently learned turned over his signed Form 5304 to someone else.  Fast forward to December 2023, when his payroll service was asked how much he could contribute for 2023? Since there was no knowledge of this plan's existence, the answer was "What plan?". 

My question is what happens now? I have an owner with 14,000 in a SIMPLE IRA that got there without payroll, nothing for any employees, and no matching. If the money is removed it will come on a 1099-R as taxable, plus it will be less than two years since it was deposited which is one penalty, early withdrawal which is another penalty, and then the penalty for the whole plan being administered incorrectly.  Since this 14,00 was already taxed, how do we fix this where the money isn't taxed all over again?

I have asked several professionals about this but I can't get any answer. I just hear this doesn't happen. 

Thank you in advance for any insight. 

 

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Just taking a stab at this without looking it up or thinking too hard...I think what you have, essentially, is an overcontribution. I think the rules for a SIMPLE would be the same as a regular IRA, i.e. you can take it out before April 15 without penalty. After April 15, there is a 6% (??) penalty. So that's where he is now, and 6% per year thereafter. That beats having the whole thing taxed.

The other stuff about not enrolling employees is a different matter. Just trying to get the ball rolling and see if anyone corrects me or otherwise picks it up.

Ed Snyder

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Going back to the beginning when the plan started seems necessary here- to ensure all compliance requirements are met. Questions that need to be answered include the following:

  1. Were employees notified and given an opportunity to make/change salary deferral elections during the 60-day period (for 2022)?
  2. Were employees notified and given an opportunity to make/change salary deferral elections during the 60-day period (for 2023)?
  3. Did the employer elect the matching or non-elective contributions? This would determine if employees were required to receive employer contributions.
  4. How was the $14,000 handled by the accountant who filed the tax return?

 

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Beyond using Appleby’s suggestions for fact-checking:

The shareholder-employee might want his lawyers’ and accountants’ advice about whether the ostensible Form 5304 or other document was a false document and about whether the account someone imagined might be a SIMPLE IRA never was a SIMPLE IRA (and might never have been any kind of IRA).

If the account never was an IRA, what tax consequences result from so amending the holder’s 2022 tax returns (removing mistaken exclusions and deductions, and recognizing whatever capital gains, dividends, and interest the taxable brokerage account paid or otherwise distributed)?

Nothing here is tax or legal advice; it’s time for each person involved or affected to get his, her, or its professionals’ advice.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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APPLEBY:

No one knew anything about this plan but the shareholder. The employees were not told and therefore had no opportunity to participate in either tax year. The financial planner didn't even know he had employees. 

The employer had a 3% match. 

There was no handling of the 14,000 on the tax return. There was no payroll withholding for the SIMPLE. He simply gave his financial planner 14,000 of personal money and this financial planner gave it to his guy handling the SIMPLE IRA. The SIMPLE was filed with the IRS because the shareholder got Form 5498 saying he had deposited 14,000 into his SIMPLE IRA for 2022. The SIMPLE only came to light when the shareholder asked how much he could contribute in 2023 because his financial planner wanted to know. 

PETER GULIA

It was a SIMPLE because the IRS received forms saying 14,000 had been deposited into the SIMPLE on behalf of the shareholder. 

I just don't know what to do when the money deposited was after tax money belonging to the shareholder. Nothing went through payroll for either year. The question now is how to fix this. If he takes the money out it will be a taxable distribution on the 14,000 which has already been taxed. There will be plan penalties, early withdrawal penalties and the plan will need to be closed out. I think it's flawed and was never a real SIMPLE regardless of the fact after tax money was deposited into it. Still, I have no idea what exactly to do.

Thanks.

 

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22 hours ago, Cheryl Merritt said:

APPLEBY:

No one knew anything about this plan but the shareholder. The employees were not told and therefore had no opportunity to participate in either tax year. The financial planner didn't even know he had employees. 

The employer had a 3% match. 

There was no handling of the 14,000 on the tax return. There was no payroll withholding for the SIMPLE. He simply gave his financial planner 14,000 of personal money and this financial planner gave it to his guy handling the SIMPLE IRA. The SIMPLE was filed with the IRS because the shareholder got Form 5498 saying he had deposited 14,000 into his SIMPLE IRA for 2022. The SIMPLE only came to light when the shareholder asked how much he could contribute in 2023 because his financial planner wanted to know. 

PETER GULIA

It was a SIMPLE because the IRS received forms saying 14,000 had been deposited into the SIMPLE on behalf of the shareholder. 

I just don't know what to do when the money deposited was after tax money belonging to the shareholder. Nothing went through payroll for either year. The question now is how to fix this. If he takes the money out it will be a taxable distribution on the 14,000 which has already been taxed. There will be plan penalties, early withdrawal penalties and the plan will need to be closed out. I think it's flawed and was never a real SIMPLE regardless of the fact after tax money was deposited into it. Still, I have no idea what exactly to do.

Thanks.

 

 

 

  1. No one knew anything about this plan but the shareholder. The employees were not told and therefore had no opportunity to participate in either tax year. The financial planner didn't even know he had employees. Response: There is a $50 per day penalty for failure to notify employees ( the employee notification is the summary description). The summary description must be provided for every year the employer continues the SIMPLE IRA plan
  2. The employer had a 3% match. Response: OK. If the summary description had been provided, this would not have been an issue, as employees who do not make salary deferral elections would not be entitled to a match. But, by not providing the summary description, the employer has the issue in No. 1
  3. There was no handling of the 14,000 on the tax return. There was no payroll withholding for the SIMPLE. He simply gave his financial planner 14,000 of personal money and this financial planner gave it to his guy handling the SIMPLE IRA. Response:  This is not a SIMPLE IRA  contribution. It is an ineligible/ excess contribution to the SIMPLE IRA, requiring correction.
  4. The SIMPLE was filed with the IRS because the shareholder got Form 5498 saying he had deposited 14,000 into his SIMPLE IRA for 2022. Response: The Form 5498 only tells the IRS that the employer made a contribution to a SIMPLE IRA. Unfortunately,that does not mean that the contribution is legitimate/valid.
  5. The SIMPLE only came to light when the shareholder asked how much he could contribute in 2023 because his financial planner wanted to know. 
  6. It was a SIMPLE because the IRS received forms saying 14,000 had been deposited into the SIMPLE on behalf of the shareholder. Response: The plan is a SIMPLE if the employer did complete the SIMPLE Employer adoption agreement (SIMPLE 5304,5305 or prototype). But, there are compliance issues which include: It appears the contribution is not a SIMPLE IRA contribution, and the required annual notification was not provided to employees. Please see 4.
  7. I just don't know what to do when the money deposited was after tax money belonging to the shareholder. Nothing went through payroll for either year. The question now is how to fix this. If he takes the money out it will be a taxable distribution on the 14,000 which has already been taxed. There will be plan penalties, early withdrawal penalties and the plan will need to be closed out. I think it's flawed and was never a real SIMPLE regardless of the fact after tax money was deposited into it. Still, I have no idea what exactly to do. Response:  Technically, it is a SIMPLE IRA is the SIMPLE paperwork was properly completed. But, there is a lack of compliance as noted above- but the employer might be able to get the penalties reduced- someone with practical experience working with the IRS on EPCRS issues should be able to say if and how. While the early distribution (pre-age 59 1/2)  penalty is 25% for SIMPLES that have not met the two year period, I think it would be 10% in this case, because the contribution is not a valid SIMPLE IRA contribution.

I hope this helps.

 

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Appleby's comments are correct. But on a practical level, this is unfixable - the costs are so open-ended it is ridiculous (penalties, fees, contributions to be made for others who weren't informed). If it's me, I explain the correct way to fix it, and then informally note that maybe it was never a legit plan at all due to all of the failures involved, and that he could either ignore everything and eventually take the money out as a taxable distribution (even though no deduction was ever taken), or take it out now as an excess contribution and pay the 6% per year excise tax. Just make it abundantly clear that the broker is the one who screwed up, and that you're not giving formal advice. Just minimize your efforts and distance yourself from the mess.

Ed Snyder

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