Qua Plan for self employed – deemed/offset distribution
Client maintains an individual k, qualified plan. She is self employed – sole proprietor. She borrows $50k and starts repayment plan. Now she commences to work as a fulltime W-2 employee. She is age 55.
Can she separate from service – from the sole prop? It is easy to see that a W-2 employee can separate from service after attaining age 55 pursuant to 72(t)(2)(A)(v)-(Distribution made to an employee after separation from service after attainment of age 55),
[u][b]Is there any prohibition from a self employed person using code section 72(t)(2)(A)(v) to avoid the 10% penalty?[/b][/u]Question #2 would be: how is separation from service documented? Other than curtailing the business activity how would the separation and ceasing of businsess be documented?
Thanks in advance
Jim
Permalink Submitted by Alan Spross on Thu, 2010-04-22 02:37
Jim,
The plan can be terminated for any legitimate business reason. Per copy of Sec 401(c) below, the owner is treated as an employee for purposes of this plan, and therefore the age 55 separation from service for employees exception to the early distribution penalty can apply.
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401(c) Definitions and rules relating to self-employed individuals and
owner-employees
For purposes of this section –
(1) Self-employed individual treated as employee
(A) In general
The term “employee” includes, for any taxable year, an individual who is a self-employed individual for such taxable year.
(B) Self-employed individual
The term “self-employed individual” means, with respect to any taxable year, an individual who has earned income (as defined in paragraph (2)) for such taxable year. To the extent provided in regulations prescribed by the Secretary, such term also includes, for any taxable year –
(i) an individual who would be a self-employed individual within the meaning of the preceding sentence but for the fact that the trade or business carried on by such individual did not have net profits for the taxable year, and
(ii) an individual who has been a self-employed individual within the meaning of the preceding sentence for any prior taxable year.
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Regarding documentation of the cessation of business, I don’t know of any specific evidence requirement, so the client should use whatever best documents this. Perhaps there is a place on the tax return depending on the schedule filed for the business. There may also be letters sent to clients of the business or local taxing authorities.
The loan is another issue altogether. With separation of service, there would usually be an offset distribution instead of a deemed distribution, and that makes the loan balance rollover eligible if the client has the funds to pay off the loan. Otherwise the loan balance would become taxable.
Permalink Submitted by JAMES MAGNO on Thu, 2010-04-22 13:24
Thank you Alan.
If it were an LLC, the filing or articles of dissolutuon would be a bright line indication of termination. I like your idea of sending letters to clients.
Unfortunately, this is not an LLC.
Thanks for your thought.
Jim