Pre-Funded Profit Sharing

Employer deposited $50k in 2019 for a profit sharing contribution not realizing they had excess DB assets of $52K  that came over from their terminated DB plan which would cover the 2019 profit sharing contribution which ended up be $44K to max out the owner. 

Question - if the CPA does not take a deduction for the $50K deposit can they just carry the $50K over and allocate it in 2020 or is there an issue with funding the plan and not allocating the money - is there a penalty for that?

When you deduct and when you allocate are not linked.  

I know of no way to not allocate these funds.  

3 hours ago, Becky Schwing said:

Employer deposited $50k in 2019 for a profit sharing contribution not realizing they had excess DB assets of $52K  that came over from their terminated DB plan which would cover the 2019 profit sharing contribution which ended up be $44K to max out the owner. 

Question - if the CPA does not take a deduction for the $50K deposit can they just carry the $50K over and allocate it in 2020 or is there an issue with funding the plan and not allocating the money - is there a penalty for that?

 

Almost definitely those funds contributed in 2019 BELONG to the participants in that year, and there is nothing you can do but allocate it in accordance with the plan document.  To NOT allocate it would involve violation of their ERISA rights and subject the fiduciaries to personal liability to the participants.

5 hours ago, Becky Schwing said:

they had excess DB assets of $52K  that came over from their terminated DB plan

Don't forget this either. If that amount transferred in 2019 you have to begin using it in 2019, either in entirety or (because that's obviously not an option here) in installments over a period not exceeding 7 years. If they fail to do so and get caught then excise taxes on the reversion (plus interest and penalties) would apply.

Along CuseFan's line.....

Could the plan run its allocation for the 50K in new money plus one-seventh the DB transfer?  I don't recall the rules as to whether or not the whole suspense account gets used before any new money contributed can be.

Yet another problem created by contributions made before the end of the year. 

On ‎2‎/‎20‎/‎2020 at 1:31 PM, Larry Starr said:

Almost definitely those funds contributed in 2019 BELONG to the participants in that year, and there is nothing you can do but allocate it in accordance with the plan document.  To NOT allocate it would involve violation of their ERISA rights and subject the fiduciaries to personal liability to the participants.

Larry, would your answer be the same if the plan document and board minutes or other corporate acts (assuming corporation, but mutatis mutandis for other types of employers), taken together, showed clearly that the contribution was not intended by the company to be allocated for 2019? We know IRS and DOL guidance on "mistake of fact" contributions (that can be retrieved within one year under ERISA) is not clear. In my experience many practitioners use suspension of erroneous contributions and allocating in next year as a fallback if in doubt, rather than being aggressive on what is a "mistake of fact."

9 minutes ago, Luke Bailey said:

Larry, would your answer be the same if the plan document and board minutes or other corporate acts (assuming corporation, but mutatis mutandis for other types of employers), taken together, showed clearly that the contribution was not intended by the company to be allocated for 2019? We know IRS and DOL guidance on "mistake of fact" contributions (that can be retrieved within one year under ERISA) is not clear. In my experience many practitioners use suspension of erroneous contributions and allocating in next year as a fallback if in doubt, rather than being aggressive on what is a "mistake of fact."

Here is a reasonable discussion of mistake of fact for those who are not intimately familiar with the term.  I am including two separate sources.  I will address the question separately in a separate response. Here is the first commentary:

A Mistake of Fact

The Employee Retirement Income Security Act of 1974 (ERISA) and its regulations, which regulate 401(k) plans, forbid the use of plan assets for anything except the exclusive benefit of plan participants and severely restrict the ability to revert plan assets to an employer. Normally, this prohibits money deposited into a plan account from being returned to a plan sponsor or participant. A “mistake of fact” error is considered an exception to this rule.  

The IRS has determined mistakes of fact to include mathematical and typographical errors occurring during the contribution process. For example, adding an extra zero to the amount remitted to the trust account for a payroll deferral or including a participant multiple times on the same report would potentially be characterized as a mistake of fact.  

Conversely, the IRS has found that there is no mistake of fact where an employer or a participant unintentionally contributes an amount that causes the plan to fail annual testing. This would include exceeding IRS contribution limits for

• Participant deferrals, 
• Compensation limits, 
• Average Deferral Percentage testing failures, 
• Average Contribution Percentage testing failures, 
• Top Heavy testing failures, 
• or Deductibility limits. 

Further, the IRS has found no mistake of fact where a participant selects an unintended deferral rate, contributions are made on ineligible compensation or an ineligible employee is allowed to participate. As they will not allow distributions as a form of correction for testing failures, the IRS has created an alternate system to allow correction for these operational errors as outlined here.

Here is the second source of commentary:

Focusing on the meaning of mistake of fact, neither the Internal Revenue Code nor ERISA (or regulations thereunder) define “mistake of fact” for purposes of qualified retirement plans. Through private letter rulings the IRS has revealed it views this exception as “fairly limited.” Consider the following excerpt from IRS Private Letter Ruling (PLR) 9144041:

Mistake of fact is fairly limited. In general, a misplaced decimal point, an incorrectly written check, or an error in doing a calculation are examples of situations that could be construed as constituting a mistake of fact. What an employer presumed or assumed is not a mistake of fact.

Plan sponsors have attempted to zero in on the meaning of mistake of fact through the request of private letter rulings. For example, in PLR 201424032, the IRS concluded that an excess contribution made to the plan based on the incorrect asset value was made because of a mistake of fact. An “erroneous actuarial computation” was a mistake of fact in PLR 201228055. A “mistaken belief about the number of participants and beneficiaries” in the plan constituted a mistake of fact in PLR 201839010.

Conclusion

While it may be permissible to return an excess employer contribution as a result of a mistake of fact, bear in mind, such mistakes are very narrowly defined by the IRS.

24 minutes ago, Luke Bailey said:

Larry, would your answer be the same if the plan document and board minutes or other corporate acts (assuming corporation, but mutatis mutandis for other types of employers), taken together, showed clearly that the contribution was not intended by the company to be allocated for 2019? We know IRS and DOL guidance on "mistake of fact" contributions (that can be retrieved within one year under ERISA) is not clear. In my experience many practitioners use suspension of erroneous contributions and allocating in next year as a fallback if in doubt, rather than being aggressive on what is a "mistake of fact."

First, let's make clear that the original posting provides no viable reason to treat the contribution made in the given situation as anything other than a contribution for the year contributed.  The mistake they made was NOT a mistake of fact.  By the way, the IRS said that only THEY can determine if there is a mistake of fact, so that makes the concept even more "unhelpful".

In this situation you are changing the facts (which is fine) so we might have a different result.  Do the facts you propose make it a mistake of fact?  Maybe.  It is of course a very fact specific determination.  In this case, we would have to know HOW the extra money got in, and if all the paperwork you mention clearly provides for something else, what happened to cause this contribution MIGHT be a mistake of fact and maybe you can take it back (within the year).  However, if you have to get IRS ruling on that, it might be moot because it could take longer than a year and then you have the problem of administering the plan in the meantime.  While it might actually be a MOF, it might not be practical to try to make that case.  Tough situation for sure. 

HOWEVER..... I see no justification to your suspension of erroneous contributions argument. If the money was contributed during the year, the plan provisions apply if you are not going to try to prove a MOF and that means that participants in the plan for that year are ENTITLED to their allocable share of those funds.  I don't see any other way around it.   

23 hours ago, Larry Starr said:

HOWEVER..... I see no justification to your suspension of erroneous contributions argument. If the money was contributed during the year, the plan provisions apply if you are not going to try to prove a MOF and that means that participants in the plan for that year are ENTITLED to their allocable share of those funds.  I don't see any other way around it. 

Larry, (a) the level of the guidance on what is mistake of fact is low, so no settled law, (b) it's an ERISA provision, so DOL has guidance authority (not ceded to IRS in the 1978 Reorg Plan), and (c) over the period I have been practicing, I have seen it done a lot, and accepted by large recordkeeper-custodians. I think it remains a gray area.

30 minutes ago, Luke Bailey said:

Larry, (a) the level of the guidance on what is mistake of fact is low, so no settled law, (b) it's an ERISA provision, so DOL has guidance authority (not ceded to IRS in the 1978 Reorg Plan), and (c) over the period I have been practicing, I have seen it done a lot, and accepted by large recordkeeper-custodians. I think it remains a gray area.

Of course it's gray; it's a legally undefined term. But go back to the original posting: no way that is going to ever be a mistake of fact. Do you disagree?

Also, I should have said only the IRS can determine that an amount is non-deductible; it's not up to the accountant or admin firm to determine that for purposes of the withdrawal of the funds.  You need a ruling from IRS.  Try and get it!

As an aside 90-49 gives minimal authority to enrolled actuaries to determine deductibility.  I know it is sort of off topic, but it provides input by the absence of similar guidance in other circumstances.

Mike and Larry, thanks for input on difficult and important issue. Perhaps this is one of those areas where the absence of guidance is attributable to following through cracks between DOL authority and IRS practical interest, like PT's in IRAs.