profit sharing calculation

[Gene E. Utterback, EA]

I am having a rather interesting "discussion" with a prospective client
regarding their company's profit sharing plan. Here are the facts as I've
received them:

Client has an S corporation, formed in 1999;
S Corporation has NEVER had any profit shown on the return;
S Corporation's financial advisor sold them a "Profit-Sharing" plan back in
2000;
S Corporation's financial advisor has had them contribute to the profit
sharing plan each year since inception - for both the owners and unrelated
employees.

Our discussion revolves around this question "how does one calculate the
employer's contributions for a profit sharing plan when the company has
never had any profits?"

I know IRS Section 401(a)(27)(A) "The determination of whether the plan
under which any contributions are made is a profit-sharing plan shall be
made without regard to current or accumulated profits of the employer and
without regard to whether the employer is a tax-exempt organization."

I believe that this only enables the establishment of a profit sharing plan
but does not specifically allow contributions in years the company has no
profit.

Any information or guidance would be appreciated.
Thanks,
Gene E. Utterback, EA

 

[MTW]

I believe that this only enables the establishment of a profit
sharing plan but does not specifically allow contributions in
years the company has no profit.

I've never let the absence of a profit slow me down on this.
Indeed, many small businesses are cleverly managed so as to
minimize or eliminate any significant profit.

My view is that the term "profit sharing" is simply a recognition
that the amount of contributions is DISCRETIONARY and can change
from year to year. Contrast this with a "pension" plan that
REQUIRES an annual contribution based on a fixed formula.

MTW

 

[Ed Zollars, CPA]

I believe that this only enables the establishment of a profit sharing plan
but does not specifically allow contributions in years the company has no
profit.

There's nothing in the IRC any longer that requires a "profit" for a
profit sharing plan. Rather, the limitations are solely based on
covered compensation, both for the contribution under Section 404
and the allocation under Section 415.

Many, many years ago I believe there was such a reference in the
code, but it no longer exists. The term "profit sharing plan" is
simply a term of art now--much like "first time homebuyer" is (you
can be buying your fifth home and still be a first time homebuyer as
far as Section 72 is concerned).