A new (calendar tax year) business is established 7/1/2003 say.

Q1. Can a plan, adopted during 2003, be made effective 1/1/2003 to make the first plan year a full 12-month year?

Q2. Does the answer differ if the new business is a Corp or a Sole Prop?

Q3. If a 12-month initial plan year is ok, Is the deduction limited to 50% of the annual(ized) 404 cost because the initial tax year is a short yr?


Any and all cites would be appreciated.

Cites? Sorry, too lazy, but I will provide my thoughts.

A1. Yes
A2. No
A3. No

I must be having a brain freeze, because I was thinking the Plan could not be effective before 7/1/03???

As I recall, the IRS in the person of Jim Holland or Dick Wickersham said at a recent annual ASPA meeting that a 1/1 effective date would be OK.

Thank you all.

Just to confrim dsyrett, are you saying that it is ok to make your plan's effective date PRIOR to your corporation's effective date?

Pushed to the limit, I could establish my corporation on 12/31/03 and create a plan effective 1/1/03 and take a full accrual and full deduction for the year (assuming my document allowed a full accrual for 1 minute of service).

I could also accrue a full $40,000 DC allocation? (ignoring combined dc/db deduction limits)

Do you happen to have a site?

I agree with Blinky and dyrett as well, but I also lack instant recollection of a cite.

OK, I've looked everywhere I can think of, I spoken to 4 or 5 ERISA attorneys and 5 or 6 actuaries and no one thinks you can do this. I'm not doubting you all (well maybe I am), but some site other than "I think Jim Holland or Dick Wickersham said it a recent annual ASPA meeting" would be helpful.

The general response I get from the attorneys is "how can I have a plan effective when no entity existed to sponsor it?"

Sorry, no cite, but as for the general attorney response, then I am sure they don't make their plan documents effective retroactively to the first day of the plan year even when the business exists. After all, "how can I have a plan effective without a plan document?".

P.S. No, I am not bashing attorneys, just the logic of this line of thinking.

That is completely different. The Regulations clearly state that you can have a retroactive effective date as long as it is all done with-in one plan year.

I guess I'll just have to add, "Blinky said so" to the list of infallible resources. I can put it after "I heard Jim Holland say it at an ASPA meeting", but before "I overheard Ira Cohen in the bathroom".

Yes, we all know that retroactive document effective dates are permissible. But it flies in the face of the logic your source attorneys are using to discount the availability of a plan in effect before an entity.

BTW, no need to get snippy now.

OK, the descending tone caused me to look this up quickly. Here's another hearsay comment for the collection. Verbatim.

The ERISA Outline Book (the version I'm quoting from is the 1998 edition, page 3.74)

The context is Chapter 3: Accruing Benefits Section IV Special Rules. There are references to earlier paragraphs that discuss problems with an initial short plan year.

"3) What if the employer was not in existence before the effective date? A plan might start with a short year because the employer was not in existence before the effective date. Suppose in the prior example that the employer did not exist before May 1, 1998. Could the plan be effective January 1, 1998, or treat the compensation period as 12 months long by specifying the calendar year (rather than the plan year) as the compensation period, as suggested in the prior paragraph? The answer is not clear. IRS personnel have expressed the view at certain employee benefit conferences that a plan's effective date can predate the existence of the employer, thereby creating a 12-month plan year and supporting the use of the full compensation dollar limit for that year. The IRS has also informally noted that the compensation period can be defined as a 12-month period, even though the company did not actually exist for that entire period, also supporting the use of the full compensation dollar limit for an initial short plan year."

While this may be addressing a somewhat different issue, it is clear evidence that some of us are not hallucinating when say we have heard these things answered in the affirmative. Now if I had Q&As in electronic format, I could probably find a Q&A on it quickly, but I don't. Effen, this may be all that exists in print other than a Q&A.

But on the deduction side the answer seems to be different. Chapter 7 Section XVI

"Pension Plans

Since the deduction limits for pension plans are based on the minimum funding standards with repect to a plan year, a short tax year or a short plan year will affect the computation of the deduction limit. The IRS' position is that the deduction limits are based on a 12-month plan year associated with a 12-month tax year. ........

a. Tax year also changes to mirror plan year change. Where the short plan year is associated with a corresponding short tax year, the prorated deduction limit applies to the short tax year."



So, regarding your third question, maybe the question is, "Is it a short fiscal year or does the fiscal year go back to 1/1"

Thank you for the response Andy and sorry to have been "snippy" Blinky.

It sounds like there probably aren't any sites and it's just something representitives of the IRS have said in public forums.

Has anyone actually done this? If you can do it, why would anyone do a short plan year in the first year?

An employer can deduct contributions made to a qualified plan which is established as of the last day of the employer tax year. Rev. Rul 81-114. Assuming that the employer can have a plan year which begins prior to incorporation of the business, eg. back to 1/1/03, then the employer could have a 12 month plan year for all comp paid up to 200k which is included in the employees income by 12/31. This would require that the business generate at least 200k in sales or income in order to pay the comp by the end of the tax year. Since profit sharing plans are not subject to the minumum funding provisons of IRC 412, the employer could pay the 200k in Dec and have it taxed as income for 2003.

In an effort to put a bow on this thread....


From the 1997 ASPA Pension Actuaries and Consultants Conference in
Washington, D.C., on October 9, 1997:

ASPA: Corporation is established in 1995 with a calendar fiscal year. A 25%
money purchase plan is set up effective 4/1/97. The plan year and the
limitation year end on 12/31. Plan covers one individual hired in 1995
whose compensation 4/1/97-12/31/97 exceeds $160,000. Compensation for plan
purposes is 75% of $160,000 ($120,000) due to short plan year, therefore
the plan's contribution appears to be $30,000. Is the 415 limit reduced for
a short plan year in this case (if no, the plan may provide the full
$30,000 for this individual)? Then, if the individual's hire date is
4/1/97, is the answer the same?

IRS: The 415 limit is not reduced for a short plan year and this individual
can receive the full $30,000. There is no short limitation year which would
reduce the 415 limit, unless the document defined plan year to equal
limitation year. If that were the case, then it would appear that the
design of the plan would be faulty. In this case, the limitation year
should be the 12 month period ending 12/31/97. If a prototype requires that
the limitation year be equal to the plan year, then you would have a
reduction. The individual's hire date is not relevant.

ASPA: A second question is if it is permissible to have a plan's effective
date precede the existence of the plan sponsor or a predecessor entity of
the plan sponsor. Thus, if we have a brand new entity set up on 3/1/97 with
a calendar year fiscal year, can we establish a PS plan with an effective
date of 1/1/97, have a full 12 month plan year, and use all compensation
paid during that 12 month period (which would be limited by the fact that
there is no payroll prior to 3/1), and not need to pro-rate any of the
regular limits?

IRS: It seems reasonable that with proper attention to the details of the
plan design (including effective dates and plan years as outlined above),
the issues that are of concern in this question can be avoided. We know of
nothing that prohibits provisions such as outlined above.

ASPA: Assume a new defined contribution plan. If a plan document defines
the limitation year as the plan year and the initial plan year is a short
plan year, is the document defective because it is not permissible to have
a "short limitation year" ? If this is a defect, would such a drafting
defect be sufficient to jeopardize the plan's qualified status.

IRS: As a practical matter, this is most likely not a problem. We are not
aware of ever saying that you cannot ever have a short limitation year.

Have the previously-mentioned multiple actuaries and attornies now changed or moderated their views?