S Corp Officer 401K Profit Sharing

[David]

S Corp officer is the sole SH of his S Corp. His wife is an employee. There are no other employees.They switched their 401K plan to AmeriTrade and it appears they didn't have much guidance.  They wanted to reduce 401K fees and it appears that everything is handled online.

In the past they both made 401K contributions (he to a traditional 401K and she to a Roth 401K) and the company made 401K matches.

The wife said they were told that they no longer need to make 401K contributions through payroll deductions but that the company can make a profit sharing contribution of 25% of their pay to the S Corp officer's traditional 401K and to the wife's Roth 401K plan.

I know the company can make a 25% 401K profit sharing contribution for each employee, including the S Corp officer. However, something appears a little fishy in that, form now on, neither will make any payroll contributions and the only contributions will be the 25% profit sharing paid by the company. Of course the company gets to write off the deduction.

I can't find anything in the regs that say the 401K participants have to contribute in order for the company to pay a profit sharing amount to each employee's 401K. So this may be fine and won't raise IRS eyebrows.

However, it appears that the 401K profit sharing to the wife's Roth 401K plan is a little suspect since the company gets the deduction and the wife will never be taxed on this amount. Maybe I'm overthinking this.... :-)

Has anyone seen this arrangement before and is it in compliance with the regs? If anyone has any cites, I would welcome them.

Thanks for your help. 

[PaulH]

I don't have any cites handy, but I'm pretty sure the company match and profit sharing have to be pre-tax, not Roth. I don't think the employee has to make an elective deferral in order to get profit sharing, but only an elective deferral can be Roth.

[Max W]

I don't see how the corp can contribute to a Roth.   The amount should be additional salary to the wife.  She can then contribute the additional amount to the Roth.

[Richcpaman]

Please keep looking into this. 

I don't believe AmeriTrade would say that.  Your client would and so would mine..

Employee's can use the 401K max Deferral into either a tax deferred 401k or a Roth 401K that is NOT tax deferred.  After that, you can do up to the 25%  Profit Sharing Match.

However....

I do not believe that you can 25% Profit Match into the ROTH.  Your matching would have to go into a regular 401K for that.

And you have to do the elective deferral into the 401K or ROTH 401k to be eligible for the match.  No Deferral, No Match.   (This is the part that the clients "miss" during the conversation")

Rich

 

 

[David]

Thanks everyone for your help on this.

I can't find cites and the only thing I can find are retirement FAQs on the IRS website.

You're correct that any profit sharing Roth contributions have to be made to a pre-tax account. That makes sense and eases my concern stated above. And there is no requirement that a plan participant makes contributions through payroll deductions in order for the company to make profit sharing contributions.

So I guess they can continue to only have profit sharing contributions made to their accounts.

Please let me know if anyone has any information that contradicts this.

Thanks.

[jklcpa]

Rich is correct.

Sorry this post is long. This link is to Cornell Law for sec 1.401(k)-1(f) "Special rules for designated Roth contributions" and should have the references you are looking for. Bolding is mine, but be sure to read all of it :

Quote

(f)Special rules for designated Roth contributions -

(1)In general. The term designated Roth contribution means an elective contribution under a qualified cash or deferred arrangement that, to the extent permitted under the plan, is -

(i) Designated irrevocably by the employee at the time of the cash or deferred election as a designated Roth contribution that is being made in lieu of all or a portion of the pre-tax elective contributions the employee is otherwise eligible to make under the plan;

(ii) Treated by the employer as not excludible from the employee's gross income (in accordance with paragraph (f)(2) of this section);

(iii) Maintained by the plan in a separate account (in accordance with paragraph (f)(3) of this section).

(2)Inclusion treatment. An elective contribution is generally treated as not excludible from gross income if it is treated as includible in gross income by the employer (e.g., by treating the contribution as wages subject to applicable income tax withholding). However, in the case of a self-employed individual, an elective contribution is treated as not excludible from gross income only if the individual does not claim a deduction for such amount. If an elective contribution would not have been includible in gross income if the amount had been paid directly to the employee (rather than being subject to a cash or deferral election), the elective contribution is nevertheless permitted to be a designated Roth contribution, provided the employee is entitled to treat the amount as an investment in the contract pursuant to section 72(f)(2).

(3)Separate accounting required. Under the separate accounting requirement of this paragraph (f)(3), contributions and withdrawals of designated Roth contributions must be credited and debited to a designated Roth account maintained for the employee and the plan must maintain a record of the employee's investment in the contract (that is, designated Roth contributions that have not been distributed) with respect to the employee's designated Roth account. In addition, gains, losses, and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. However, forfeitures may not be allocated to the designated Roth account and no contributions other than designated Roth contributions and rollover contributions described in section 402A(c)(3)(B) may be allocated to such account. The separate accounting requirement applies at the time the designated Roth contribution is contributed to the plan and must continue to apply until the designated Roth account is completely distributed. A-13 of § 1.402A-1 for additional requirements for separate accounting.

(4)Designated Roth contributions must satisfy rules applicable to elective contributions -

(i)In general. A designated Roth contribution must satisfy the requirements applicable to elective contributions made under a qualified cash or deferred arrangement. Thus, for example, a designated Roth contribution must satisfy the requirements of paragraphs (c) and (d) of this section and is treated as an employer contribution for purposes of sections 401(a), 401(k), 402, 404, 409, 411, 412, 415, 416 and 417. In addition, the designated Roth contributions are treated as elective contributions for purposes of the ADP test. Similarly, the designated Roth account under the plan is subject to the rules of section 401(a)(9)(A) and (B) in the same manner as an account that contains pre-tax elective contributions.

(ii)Special rules for direct rollovers. A direct rollover from a designated Roth account under a qualified cash or deferred arrangement may only be made to another designated Roth account under an applicable retirement plan described in section 402A(e)(1) or to a Roth IRA described in section 408A, and only to the extent the rollover is permitted under the rules of section 402(c). Moreover, a participant's designated Roth account and the participant's other accounts under a plan are treated as accounts held under two separate plans (within the meaning of section 414(l)) for purposes of applying the automatic rollover rules for mandatory distributions under section 401(a)(31)(B)(i)(I) and the special rules in A-9 through A-11 of § 1.401(a)(31)-1.

(5)Rules regarding designated Roth contribution elections -

(i)Frequency of elections. The rules under paragraph (e)(2)(ii) of this section regarding frequency of elections apply in the same manner to both pre-tax elective contributions and designated Roth contributions. Thus, an employee must have an effective opportunity to make (or change) an election to make designated Roth contributions at least once during each plan year.

(ii)Default elections - (A) In the case of a plan that provides for both pre-tax elective contributions and designated Roth contributions and in which, under paragraph (a)(3)(ii) of this section, the default in the absence of an affirmative election is to make a contribution under the cash or deferred arrangement, the plan terms must provide the extent to which the default contributions are pre-tax elective contributions and the extent to which the default contributions are designated Roth contributions.

(B) If the default contributions under the plan are designated Roth contributions, then an employee who has not made an affirmative election is deemed to have irrevocably designated the contributions (in accordance with section 402A(c)(1)(B)) as designated Roth contributions.