Retirement Trustee Experts - Opinions Please

[BulldogTom]

Here is the scenario:

C Corporation has a profit sharing benefit plan for the employees. When the economy took a dump, most of the employees were laid off or left the company and took their retirement money with them. The plan does not allow for loans to be made to the beneficiaries. The normal process is for the plan to distribute the cash to the corp, who in turn distributes the cash to the beneficiary and issues a 1099R for the distribution.

The Corp President and Sole Shareholder is the trustee for the plan. All money left in the plan is 100% vested to him.

No contributions to the plan by the corp in over 5 years.

Hypothetical Question - If the trustee distributes the money in the plan directly to the Corp, and the Corp does not distribute the money to the beneficiary, does the Beneficiary have an individual tax liability? What are the consequences to the plan and the Corp if they employ this scenario?

Yes, the trustee of the plan, the Corp, and the Beneficiary are all one in the same.

Thanks for your thoughts..

Tom

Hollister, CA

[kcjenkins]

Seems like this is a "substance over form" issue. I think the IRS would look at this as the money being distributed to him, and he then invests it into the company, don't you? I'm nowhere even close to being an expert on retirement trusts, Tom, so don't rely on this. I just present it as a way of thinking about the problem, which may help direct your research. Clearly, if a significant amount is involved, you want some authoritative cites before you make a move, but this is where I would start in thinking about it.

[kcjenkins]

You'd have to read the trust documents, but I very much doubt if the trust is allowed to invest in the company, which is the only way I can see that you could avoid giving him a 1099 and taxing hmi on it. And depending on his age, might have early withdrawal penalties as well as income tax. You know how strict the retirement rules are, I know.

[jainen]

>>doubt if the trust is allowed to invest in the company<<

In the early days of Internet advice (which of course is all still out there), some lawyers made a few bucks promoting a scheme to have a solo 401(k) invest in the beneficiary's own company. Maybe there is a narrow way to do it, but generally it's a prohibited transaction. It looks like cheap money, but can end up very expensive.

[BulldogTom]

You are echoing what I thought myself. My take on how the IRS would recast it looks like this.

1. Early distribution from a retirement plan to the President. Taxable as ordinary income and 10% penalty tax. State penalty tax as well.

2. Cash is a contribution of capital to the corp and increases basis and any return of that cash to the Shareholder is a dividend (no deduction to the corp and income again to the shareholder).

The other concern is an accuracy related penalty on the individual tax return.

I don't know if the plan or the trustee of the plan would incur some liability on the plan tax return for the transaction (I don't do benefit taxes - so that is speculation).

Finally, I think the Corp would have some worry as well, as the plan distributed funds for the benefit of a beneficiary, and the corp confiscated those funds. I think the Department of Labor or whoever oversees benefits would have a fit about that and have some penalties in store for the corp (but again, I am guessing).

Do you think I am reading this correctly?

Tom

Hollister, CA

[kcjenkins]

Yes. you are reading it just as I would. The trust would not have a penalty, because they did just what they should do. However, the corp then had the responsibility to pay that money over to the bene, so if they did not pay it out to him, the corp officer who made that decision could be liable tor civil and maybe even criminal penalties. So the assumption that he made the choice to invest the money into the corp is actually the best assumption for him.

[jainen]

>>Do you think I am reading this correctly?<<

Dunno-- why don't you ask these guys? http://www.catchfirefunding.com/self-directed-401k.html

[JohnH]

They sure chose an appropriate name for their company.

Are we thinking double entendre here?

[SaraEA]

Good grief! Retirement plans are governed by ERISA, which is mainly the responsibility of the Dept of Labor although the IRS does police some of the requirements. I would tell this client that he needs to contact a labor attorney. Your expertise is with the tax code (Title 26, not Title 29 of the Federal Code). Treat him just like clients who ask questions about Social Security. While we can answer the easy ones, even though they have nothing to do with tax, usually it's better to refer them to SSA.