Sole Prop Average Comp

Sole proprietor with no employees, business started in 2018, plan effective in 2018. This is a takeover plan. Using made up numbers this is what has happened each year from 2018 - 2020: earned income = $100,000 and pension contribution = $99,000. In my mind that means that "plan compensation" is $1,000, which means that since there is no salary history prior to the plan effective date there are going to be a number of problems, not the least being the 415 limit since since 3 year average average comp is $1,000. Am I missing something here wrt plan comp and 415?

Assuming that you are just simplifying for the purposes of this discussion - since the net earned income calc is a little more involved than just earned income minus plan contributions - then yes, you are correct. The contribution will reduce net earned income, which will reduce the high-3 average comp for 415.

If this is the sponsor's only plan, then you can use the $10,000 de minimis 415 limit (prorated for years of service), which is not much, but it's better than $1,000.

Except the $10,000 de minimis benefit can’t be paid out as a lump sum.

And de minimis provisions have to be in the plan document, correct? How do you go back to 2018?

99k/year is a big number to be generated on de minimis especially where 415 may be limit due to lack of 10 years of service, as CB indicated.

Any chance there was also a corporation adopting the plan? 

Are you sure the $100k earned income has not already been reduce by the $99k?

Best if you go back to the client/CPA and get the schedule c information (preferably copies) and deductions taken for all years. Just because they put does not mean they deducted it. Kac1214 made a good point on this. Never assume what that is not clear/confirmed.

On 3/3/2022 at 2:54 PM, DBnme said:

Sole proprietor with no employees, business started in 2018, plan effective in 2018. This is a takeover plan. Using made up numbers this is what has happened each year from 2018 - 2020: earned income = $100,000 and pension contribution = $99,000. In my mind that means that "plan compensation" is $1,000, which means that since there is no salary history prior to the plan effective date there are going to be a number of problems, not the least being the 415 limit since since 3 year average average comp is $1,000. Am I missing something here wrt plan comp and 415?

Since this is a takeover and 2021 hasn't been done, I'm assuming it's an EOY val, with a fixed dollar accrued benefit?  BOY is usually preferred for this strategy,  but without an income history there is a little bit of leniency to project the 415 comp limit.  However, if the business growth has not been as stellar as expected, resulting in an appreciable 415 comp average; in year 4 this falls apart and you'll likely end up overfunded and 0 contribution. This may then start a seesaw effect because now you should end with an appreciable average compensation, but it can take until year 6 to flatten out.  I.e. year 4, no contribution, creates compensation average; year 5, possible contribution, if so then same average compensation; year 6, no contribution, but now have average compensation based on 2 years; level results from now on.

Also, this can be used when insurance will be a major asset, yes you still have a low compensation average, but your assets level may be depressed until year 3 when the cash values start to accelerate.  Then your contribution swings are more level since you aren't so overfunded. 

Appreciate the replies and helpful info. How would one go about correcting the situation? As stated there were "excess contributions" in terms of 415, but not necessarily for 404. I'm assuming actuarial valuations and tax returns would need to be revised? Would contributions need to be returned or could they be carried forward?  

Did the valuations support the contributions under 404 & 430? If they did and your comfortable with the results, you're done but probably have an over-funded DB Plan right now.

If you have to go back and redo the valuations and the contributions were above the deductible limit you have nondeductible contributions subject to excise taxes in one or more prior years and probably some amended tax returns to file and you probably still have an over-funded DB Plan right now.

3 hours ago, DBnme said:

Appreciate the replies and helpful info. How would one go about correcting the situation? As stated there were "excess contributions" in terms of 415, but not necessarily for 404. I'm assuming actuarial valuations and tax returns would need to be revised? Would contributions need to be returned or could they be carried forward?

The actual valuations would need to be reviewed, but it sounds like you have an overfunded Plan, nothing more.(But no, they do not get returned; although I forget how they figure into the next year's FT and AFTAP).  Or is your actuary unable to get within 5% of 2020's results so as not to cause a method change with the takeover?  Probably best to let them and the prior actuary squabble over it.