If the IRS comes knocking, are you prepared?

If you are lucky enough to be one of the very small percentage of qualified plans that is chosen for audit, will you have all the necessary documentation?  An Employee Plans (EP) Examination is an extensive look into the inner workings of your plan to ensure compliance.  Among other things, you will need to have proof of the following:

1)    You are using correct compensation according to the definition in your plan document.

2)    Employee 401(k) deferral payments are up to date and being made timely.

3)    Compliance testing for employee deferrals, employer contributions, top heavy status and other benefits, rights and features is accurately being monitored.

4)    Distributions are being made timely and reported accurately.

5)    All documents and amendments are current and signed.

6)    You have an adequate ERISA bond covering the plan.

7)    Federal tax forms are consistent with plan reports.

An EP Examination will begin with you explaining to an agent the practices and procedures of the plan.  This will shape the focus of the audit and allow the agent to gain insight into the operation and administration of the plan.

The agent will then scrutinize and evaluate the documentation listed above.  Additional information may be requested before the agent provides you with a list of corrections that must be made.

Finally, you will receive a letter based on the agent’s report.  If all has gone well, the letter will be a “no change” letter.  If serious problems are discovered, you may be offered an opportunity to correct them (upon payment of an appropriate sanction) under the Audit Closing Agreement Program to avoid disqualification. If no common ground can be found, the agent’s determination may be contested or appealed, and ultimately can be litigated.

In the way that you have an emergency preparedness kit at home, so should you in the event that you are chosen for an EP Examination.  However, if the IRS does come knocking, you are entitled to representation.  Please do not hesitate to contact The MandMarblestone Group for any audit needs.  You do not have to be a current client to be represented for an EP Examination.

Seven Sins That May Arise During Retirement Plan Examination

Don’t let what you know (or don’t know) about your retirement plan keep you awake at night.

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2013 TAX RETURNS AND RETIREMENT PLAN CONTRIBUTIONS FOR LLCS, PARTNERSHIPS & SOLE PROPRIETORSHIPS ARE DUE ON APRIL 15, 2014

As mentioned in our February blog, an advantage of a qualified retirement plan is that a deduction may be taken on the plan sponsor’s tax return for contributions to the plan even if the contribution is not made during the tax year for which the return is being filed.  As long as the contribution is paid to the trust no later than the due date (including extensions) of the sponsor’s return, it may be accrued and deducted.

Entities that are taxed as partnerships or sole proprietorships generally must file their business tax returns by April 15^th, as well as the personal tax returns for business owners.  If the 2013 tax returns are being filed timely, then all retirement plan contributions must be funded by April 15, 2014.  However, if the entities and owners file for tax extensions, then more time is granted for funding the contributions.  Below are some basic guidelines for when retirement plan contributions must be deposited for these types of entities:

• 401(k) deferrals generally must be deposited within seven business days of their withholding from payroll. There is an exception for self-employed business owners as long as the election to defer is made by year-end.  In this case, the deferrals for 2013 must be deposited as soon as practicable after the owner’s compensation for the year is determined, but in no event later than April 15, 2014 (unless the return is extended).
• Partnerships and LLCs taxed as partnerships must deposit 2013 employer contributions by April 15, 2014, or if an extension is filed, by September 15, 2014.
• Single-member LLCs and sole proprietorships must deposit employer contributions by April 15, 2014, or if an extension is filed, by October 15, 2014.
• Regardless of entity type, all 2013 pension plan (such as defined benefit, cash balance, or money purchase) contributions must be funded by the minimum funding deadline of September 15, 2014 for calendar year-end plans (or sooner if an extension was not filed).

Lastly, if your LLC, partnership or sole proprietorship has already filed the 2013 tax return and did not deduct the desired employer contribution, there may still be hope.  Options include amending the 2013 tax return or delaying the tax deduction until 2014 as long as the contribution is deposited in 2014.  Contact the MandMarblestone Group for related guidance.

INTERNAL REVENUE SERVICE ANNOUNCES OPENING OF DEFINED CONTRIBUTION PLAN RESTATEMENT WINDOW

The Internal Revenue Service has issued Announcement 2014-16, which states that it expects to issue new advisory and opinion letters on March 31, 2014 for pre-approved Master and Prototype (M&P) and Volume Submitter (VS) defined contribution plan documents.  Plan sponsors will then have until April 30, 2016 to adopt these documents in order to have assurance that their plans (generally 401(k) plans, profit sharing plans and money purchase pension plans) remain tax-qualified.  Our own VS document was submitted to the IRS for pre-approval, and we would expect to receive our new advisory letter on March 31.  We will begin restating all of our clients’ defined contribution plans shortly thereafter.

The IRS will open its program for obtaining individual determination letters on May 1, 2014, with that program also running until April 30, 2016.  However, the IRS is trying to limit the number of applications that it receives for individual determination letters.  M&P documents will no longer be able to apply for an individual determination letter on Form 5307 (at the relatively modest cost of $500), thereby limiting plan sponsors’ reliance upon their IRS opinion letter if they make any changes to the M&P document.  M&P documents with changes would have to apply for an individual determination letter on Form 5300 (at a cost of $2500). VS documents with minor changes, on the other hand, can still apply for an individual determination letter on Form 5307.

It has been our goal in drafting our new VS document to make it flexible enough so that few, if any, of our clients would need to apply for an individual determination letter.  We anticipate that most of our clients will have complete reliance upon our IRS advisory letter.

COMPENSATION ISSUES FOR PLANS – W-2 vs. S INCOME

As discussed in our prior blog, CORPORATE TAX RETURN FOR CALENDAR YEAR PLAN SPONSORS IS DUE MARCH 17, we have spent the last few weeks calculating corporate contributions to retirement plans for 2013.  One of the issues that we come across from time to time is the reporting of compensation for shareholders in S corporations.  We find that many of these shareholders are taking modest amounts of W-2 compensation, with the balance of their compensation being reported as S distributions from the corporation.  We are often told that the reason for this allocation of income is to minimize FICA and Medicare expense. An individual who received $55,000 in W-2 compensation and $200,000 in S income in 2013 saved more than $13,000 in FICA and Medicare expense compared to the individual who received $255,000 in W-2 income alone (the FICA tax rate is 6.2% on both employee and employer up to the Social Security taxable wage base, and Medicare expense is 1.45% on both employee and employer on all wages).

The problem is that for retirement plan purposes, only W-2 income can be used for calculating contributions to the plan.  If the individual in question is the sole employee of the S corporation, contributions to a 401(k) plan would be limited to $31,250, instead of the $52,000 available to the employee taking the full amount of compensation as W-2 income (i.e. $55,000 x 25% + $17,500).  Even worse, if the corporation has employees also covered by the plan, the expense for additional employees would more than offset any savings in FICA expense.

EXAMPLE: (1) Our S corporation shareholder wants to maximize contributions to the plan in 2013.  He has staff payroll of $300,000.  If he takes $255,000 in W-2 compensation, and the plan cross-tests exactly at the gateway (i.e. he gets the maximum for the minimum staff expense), he will be able to get a $51,000 contribution (including 401(k) deferrals) for a staff cost of $13,137.

(2) If our S corporation shareholder takes only $55,000 in W-2 compensation, he will be able to get a $51,000 contribution (including 401(k) deferrals) for a staff cost of $60,909.

The moral of the story is that in an attempt to save some FICA/Medicare expense, an S corporation shareholder who minimizes his W-2 compensation can foolishly blow up his retirement plan design. The Internal Revenue Service also may have non-plan related concerns about avoidance of FICA and Medicare taxes.