Cash Balance Plan when selling a business

[FloridamanMD]

Hello - This forum has been a great help in the past. I had a question about how a Cash Balance plan could interact with a significant capital gain, such as selling a business. Could a Cash balance plan be started in the year of an expected large capital gain and then have a large contribution made to the Cash Balance plan to defer taxes?

Profit sharing 401(k), unrelated business solo 401(k) already maxed. Significant capital gain for this writer would be high six or low seven figures.

Thank you.

[Hank]

I’m not sure you’d want to take capital gains (sale of practice) and turn it into ordinary income (traditional taxable proceeds from a defined benefit / pension plan.

[FloridamanMD]

I’m not sure you’d want to take capital gains (sale of practice) and turn it into ordinary income (traditional taxable proceeds from a defined benefit / pension plan.

Thank you, so only ordinary income is able to be contributed to a defined benefit/Cash Balance plan?
If the business had been owned for less than one year, and the proceeds were to be taxed at ordinary income levels regardless, could the Cash Balance plan be a better option then? How could including a prior service allocation potentially offset the reduction in potential contribution because of funding other retirement accounts?

[Steven Podnos MD CFP]

You should really talk to a pension expert. Your profit sharing contribution will be affected by the use of a CB plan. If you are young, the lower allowed CB contribution based on age might not be "worth it' due to this limitation. Also notice that you should fund the plan for at least three years in a roughly similar amount to avoid IRS scrutiny (based on the very reason you mention-trying to shelter a one time income).

[zlandar]

I don't think you can use CBP to defer capital gains on selling a business.

Maybe a 1031 exchange if there is real estate involved. If you have a brokerage account now would be a good time to harvest any tax losses to offset the gain.

[spiritrider]

It doesn't matter whether this investment income is treated as capital gains or ordinary income, because only compensation is eligible for retirement plan benefits. Is this business a sole proprietorship, partnership or S-Corp?

Only self-employed earned income which does not include the gain from the sale of the any capital asset except for good will or S-Corp W-2 compensation can be used for retirement plan benefits.

You very likely have a much bigger problem. It is generally irrelevant that two businesses are unrelated. What matters, are the employers related. You most likely have a controlled group and serious 401k plan compliance errors that will be an expensive mess to clean up.

[litovskyassetmanagement]

Hello - This forum has been a great help in the past. I had a question about how a Cash Balance plan could interact with a significant capital gain, such as selling a business. Could a Cash balance plan be started in the year of an expected large capital gain and then have a large contribution made to the Cash Balance plan to defer taxes?

Profit sharing 401(k), unrelated business solo 401(k) already maxed. Significant capital gain for this writer would be high six or low seven figures.

Thank you.

What do you mean by 'unrelated'? If you own 100% of both businesses, they are related via a controlled group rules for retirement plan purposes. This would mean you get one 415 limit. If you own less than or equal to 50% (sometimes 80%) of one of the businesses, then you don't have a controlled group, and you can have two separate 415 limits. And in the case of a controlled group this would also mean that you need to coordinate your retirement plans. So, for example, if you maxed out a solo 401k plan, chances are your CB plan contribution will be very small due to 6% profit sharing limitation. And it also depends on whether you have employees. So this is not enough information. However, if you set up a plan that covers both businesses, you can certainly make a contribution into a CB plan, but you can't make one larger than your annual allowance (which means that if you are young this won't work out as intended if the cost of the business is fairly high relative to the amount you can contribute). So there is a whole lot of variables here that need to be narrowed down (starting with the entity ownership, income from each, total contribution amount, etc, etc).

[AlexDDS]

It doesn't matter whether this investment income is treated as capital gains or ordinary income, because only compensation is eligible for retirement plan benefits. Is this business a sole proprietorship, partnership or S-Corp?

Only self-employed earned income which does not include the gain from the sale of the any capital asset except for good will or S-Corp W-2 compensation can be used for retirement plan benefits.

You very likely have a much bigger problem. It is generally irrelevant that two businesses are unrelated. What matters, are the employers related. You most likely have a controlled group and serious 401k plan compliance errors that will be an expensive mess to clean up.

He can not use sale proceeds for compensation and will need earned income or w-2 for compensation , but still can use sale proceeds to fund Cash Balance plan .

[spiritrider]

He can not use sale proceeds for compensation and will need earned income or w-2 for compensation , but still can use sale proceeds to fund Cash Balance plan .

Incorrect.

Contributions to employer retirement plans regardless of the type, must be based on compensation.

[AlexDDS]

Incorrect.

Contributions to employer retirement plans regardless of the type, must be based on compensation.

Yes , contributions must be based on compensation but what prohibits you from using that cash to fund retirement plan contributions that are based on earned income ?

[spiritrider]

As I already pointed out capital gains and most other investment income of a business are not earned income. The OP could certainly use their other earned income for cash balance contributions.

However, the OP was specifically talking about using capital gains from the sale of a business as basis for Cash Balance plan contributions. To significantly offset those taxes from high-six to low-seven figure proceeds. That is not allowed.