Establishing a Sec. 401(k) plan.

• Author: Ellentuck, Albert B.
• Position: Case study

Editor's note: This case study has been adapted from "PPC Tax Planning Guide--Closely Held Corporations," 12th Edition, by Albert L. Grasso, R. Barry Johnson, Linda Ketter-Craig, Lewis A. Siegel, Joan Wilson Gray, Richard L. Burris, James A. Keller and Gregory B. McKeen, published by Practitioners Publishing Company, Fort Worth, Tex., 1999.

Facts: Infinity Design, Inc. (IDI) is a closely held corporation involved in engineering design work. IDI's stock is equally owned by James Jackson and Joe Johnson, both registered professional engineers. In addition to the two stockholders, the company employs 12 other engineers, five technicians and two administrative employees. The corporation projects gross receipts of $2.5 million and a net profit of $200,000 for the current year. The company has a stable workforce and all current employees have been working for IDI for over one year. James and Joe would like to establish a retirement plan for the corporation's employees as a way of deferring taxability of some of their own current income and to provide an incentive for the other employees to remain with the company. Most of the employees have also expressed a desire to be able to defer some of their current taxable income to later years. However, James and Joe are concerned about the cost of such a plan, and about the ability of the company to continue to make contributions in future years.

Issue: What type of retirement plan can IDI adopt that will meet the company's objectives?

Analysis

There are many types of retirement plans available. For various reasons, James and Joe are not enthusiastic about the normal corporate defined benefit or defined contribution plans. They are intrigued by the administrative ease of a savings incentive match plan for employees (SIMPLE) plan, but would like to be able to defer more than $6,000 per year of their salaries. A simplified employee pension (SEP) plan is also a possibility, but it does not provide deferral for employees and does little to bind them to the corporation (as they are immediately 100% vested in their accounts).

After discussing the various alternatives, James and Joe decide they would like to adopt a qualified cash or deferred arrangement, also known as a Sec. 401(k) plan, for the following reasons:

1. This plan provides a method for each employee to defer a portion of his own salary, as well as have the company provide additional funds for retirement.

2. The plan can have a vesting schedule for...