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Short sponsor year and full plan year


Jakyasar

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Hi

Sole prop, started biz 7/30/2023, over age 50.

Wants a 401k plan for 2023 (ok under SECURE 2.0)

Made 125k of net c for 2023. Assume after SE tax adjustment

I think I can make the plan effective 1/1/2023 and get the full 30k as deferral, correct?

If I start the plan, do I need to prorate the 30 to 5/12th?

For PS I can do max 25k and is this doable with either full or short plan year?

Thanks

 

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The 402(g) limit is always a calendar year limit. No need to prorate it.

The 415(c) and 401(a)(17) limits may be prorated for a short plan year, although not necessarily for an initial short plan year. Check your plan document to see if it has special language about an initial short plan year.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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I am not sure the effective date of the plan could precede the date on which the business was established, so I think you will need to use July 30, 2023 for the effective date of the plan.

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I recall prior discussions in this forum concerning the potential for the effective date of the plan to precede the establishment of the business. I do not recall the consensus opinion, or if there was one.

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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I agree but the debate is - can you have full year when the biz starts in the middle of the year? I have seen this done this way and ok'ed by many but some practitioners state that it is a no, you cannot start prior to biz start date. We had this conversation sometime ago, just cannot find it (do not have time to research till after 15th)

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56 minutes ago, Jakyasar said:

I agree but the debate is - can you have full year when the biz starts in the middle of the year? I have seen this done this way and ok'ed by many but some practitioners state that it is a no, you cannot start prior to biz start date. We had this conversation sometime ago, just cannot find it (do not have time to research till after 15th)

I think it is OK but I can see the argument for proration. I don't know if there is a definitive answer. If there is hopefully someone will post a citation.

Also I believe the answer might changed whether you have a self-employed, especially schedule C entity, or a corporation as I don't recall that you file a short year schedule C.

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See https://www.irs.gov/retirement-plans/plan-sponsor/401k-resource-guide-plan-sponsors-starting-up-your-plan

"Effective date of plan. The plan may not be made effective earlier than the first day of the employer's tax year in which the plan was adopted. In other words, an employer may adopt the plan document on the last day of its tax year, with an effective date retroactive to the first day of that tax year, but not any earlier."

A CPA firm discusses the topic of Determining When a Business Starts for Tax Purposes

"When deciding to open a business, it is important to understand when a business has started for tax purposes. It is normal for a new business owner to misconstrue when the company is liable for taxes. In some cases, a business owner may believe that their company must only pay taxes when they start advertising or when the company draws in clients and begin to earn income. However, for tax purposes, the start date does not consider these factors.

Normally, the start date for a business is when the business is registered. This means that a company like an LLC or a partnership is responsible for paying taxes on the date they register with a particular state. Note, however, that it may be possible for a business to choose their start date.

Additionally, when registering a business with a state, a company is often required to also register with the IRS in order to receive an Employer Identification Number (EIN). A company’s EIN is used to identify the company for tax purposes.

It is important to note that the start date of a business can change depending on other factors. For example, under certain circumstances, the IRS may analyze a company’s activities to determine whether they are liable for taxes."

Taken together, these steps seem appropriate:

  • The starting point is for a business first to decide what will be its ongoing tax year. 
  • Next the business should decide when its first tax year began. 
  • Then the business can decide when the beginning and ending date it wants to have for its plan's ongoing plan year. 
  • Finally, the business can decide on the beginning date of the first plan year - subject to the IRS comment above.

Once the first plan year is determined and if it is a short plan year, then the rules applicable to pro-rating limits over a short plan year come into play.

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