Old Keough Provisions

[Snaggletooth]

One gentlement set up an old Keough plan years ago, back when they were the rage of the age.

He has been contributing 12% and matching 12% for his 3 employees who qualify. However, instead of directly sending the money to the plan, he writes his employees a check, and THEN they send this money to the plan.

I have maintained that the payment for the 12% to his employees are taxable wages, then each employee gets to deduct whatever they pay in as a conventional IRA. He disagrees with me and says the scenario he currently uses is what is required under terms of the Keough.

I honestly don't know. Keoughs are obsolete but they may have been grandfathered in. What say ye?

[Koss]

Keogh Plan

I want to make sure I understand what he's doing, before I try to answer.

For every $100 of wages earned by an employee, the plan receives--

$12 that comes from the wages, as a payroll deduction, and

$12 that is not coming from the wages, but rather from the employer. He is not treating it as part of the gross wages. He is giving the money to the employee, outside the payroll system, and the employee is then sending it into the Keogh plan.

Right?

Assuming for the moment that I am correctly interpreting the original post, my next questions are:

With respect to the $12 that is not coming from the wages, is he treating that as an employer contribution?

With respect to the $12 that is coming from the wages, is he treating it as a deductible employee contribution? In other words, is he backing it out of the gross wages, so that it is not included in Box 1 of Form W-2 at the end of the year?

My understanding of these plans is the following:

The employer contribution is not taxable to the employee, and it should not be included in the gross wages;

the employer contributions is deductible for the employer;

the employee contribution is voluntary, and cannot be required;

the employee contribution is not deductible; it is included in the gross wages.

I agree that it is odd that he is paying the employer contribution to the employees, and they are then sending it into the plan. That doesn't sound like the correct procedure for a Keogh plan; that sounds like the procedure for a SEP.

But it is the plan documents, and the plan rules, that govern. If the contributions are properly accounted for, it may not matter that the money was temporarily in the custody of the employee. If the money is not treated as a part of the gross wages, and is treated as an employer contribution, and the money is going from the employer to the plan, the fact that it passed through the employees hands, due to a clerical error or procedural misunderstanding, may not have any impact.

I realize that this could be a chicken-egg sort of issue, or a very thorny question of form over substance.

But I'm not sure it's really that kind of problem. The procedural mechanism is not what determines what kind of plan he has. The plan is determined by the original documents that were used to establish the plan. In my view, making the payment to the plan by giving it to the employee, who then sends it to the plan, does not change the character or the nature of the payment. What matters is the rules of the plan, and the intent of the parties.

It's probably not the right way to do it, and he should probably stop doing it that way. But I don't think it destroys the structure of the plan, and I don't think it necessarily transforms the money into taxable income.

BMK

[veritas]

Keogh plans

haven't seen one in years.

Who prepares the form 5500?

[Snaggletooth]

More

Veritas, not me. I refuse to do ANY 5500s. Penalties are too high.

Mr. Koss, the situation is as presented in the original post, awkward though it might be. What has caused the problem is one of the employees actually sent her money to a Roth, which is non-deductible. The employer is now claiming the 12% paid to her is now taxable.

I must agree. But this is the only employee who has not put their money into the plan. I agree the equilibrium has been destroyed and there should have been income. However, if the money had been put on her W-2, then the problem would have solved itself.

[JohnH]

Tell him he can switch to a SEP and avoid all the hassle. In most cases, SEP plans are superior to anything else out there.

[ChEAr$]

Ron, get him to produce original paperwork regarding the KEOUGh plan.

It might have been a generic plan of some brokerage firm, and maybe even back then, whenever "then" was it was permitted to do as he says. But if so I would wager IRS made them amend the plan to conform to the way we all know should be.