New Employer - Short Tax Year

[Gilmore]

A new company's inception is 9/1/2025.  There is one employee, the S-Corp owner.  First tax year runs 9/1/2025 to 12/31/2025.  Owner wants to adopt a calendar year profit sharing only plan for 2025, adding 401(k) for 1/1/2026.  W2 comp for the period 9/1/2025 to 12/31/2025 will exceed $350,000.  In the EOB it seems to indicate that it is possible for the effective date of the plan to begin prior to the inception date of the company.   The EOB indicates that the IRS informally expressed this view at benefit conferences.  It also notes that the employer can highlight the issue in the plan's determination letter request which seems to indicate that this wording has been in the EOB for a long time.

Is this an acceptable approach?  

If not, and the plan year must be a short plan year (9/1/2025 to 12/31/2025) to run as a calendar year plan, are we then prorating the compensation limit to $116,667 (4/12ths) and in turn using that pro-rated limit to determine the max deductible amount of $29,167 (25% of prorated limit).

Thank you very much.

 

[Belgarath]

Arggh. Going from memory only, (so don't trust me) the problem is less about the plan year (if you subscribe to the theory that the plan year can begin prior to company being formed - we've done it, and upon audit IRS never questioned it) than it is the short taxable year. With a short taxable year, the 404(a)(3) limit is based on compensation for that short period, and the compensation limit is prorated to calculate the deduction limit.

Hopefully someone with a sharper memory can point out corrections to the above...

[Peter Gulia]

Consider:

Did the corporation decide some of its employee’s compensation to be paid in the last four months of 2025 based on the now-employee’s before-incorporation work as an organizer?

When does the employer pay its employee? If a corporation’s only employee also is the corporation’s shareholder, might the employer pay wages as infrequently as once a year?

“No proration required for participation for less than a full plan year.  Notwithstanding paragraph (b)(3)(iii)(A) of this section, a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan. In addition, no proration is required merely because an employee is covered under a plan for less than a full plan year, provided that allocations or benefit accruals are otherwise determined using compensation for a period of at least 12 months. Finally, notwithstanding paragraph (b)(3)(iii)(A) of this section, no proration is required merely because the amount of elective contributions (within the meaning of § 1.401(k)-6, matching contributions (within the meaning of § 1.401(m)-5, or employee contributions (within the meaning of § 1.401(m)-5 that is contributed for each pay period during a plan year is determined separately using compensation for that pay period.” 26 C.F.R. § 1.401(a)(17)-1(b)(3)(iii)(B) https://www.ecfr.gov/current/title-26/part-1/section-1.401(a)(17)-1#p-1.401(a)(17)-1(b)(3)(iii)(B).

This is not advice to anyone.

[Gilmore]

Thanks Belgarath.

Peter, this is a brand new corporation started 9/1/2025.  The owner worked for an unrelated company prior to 9/1/2025 and started his own business 9/1/2025.  He deferred the max into his prior employer's plan in 2025 which is why no 401k needed for 2025 in the new corp's plan.  

I was trying to see if there was a way to set up the plan so that proration was not needed.  Based on Belgarath's comments it appears the plan is not the issue, but rather the short corporate tax year is the issue.

[David D]

I believe the issue here is the limitation year.  You cannot have a limitation year that precedes the date of incorporation, so that first year would be pro rated.

[Gilmore]

15 hours ago, David D said:

I believe the issue here is the limitation year.  You cannot have a limitation year that precedes the date of incorporation, so that first year would be pro rated.

If you set the limitation year as the calendar year I believe it can be the full 12 months.  After checking further I think Belgarath was correct that the short tax corporate tax year requires the compensation limit to be prorated.