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Lori H

PS contributions calculated as Corp. not Self employeed

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A 4 participant PSP historically has been allocating contributions as a Corporation. 2005 plan year each participant received 20% of their comp as a contribution. The doctor and sole HCE, received the$42K max. We just discovered through their CPA that this company is a sole proprietor. Therefore, it appears as if the plans PS contributions have been erroneously calculated, possibly since plan inception. The Doctor comp on census has always been reported in excess of 401(a)17, with the exception of this year when their CPA advised his comp to be $212,671 as his "net self-employment earnings from the clinic before any deduction for contributions to the plan or half of his self-employement tax". This is where we discovered the sole proprietor status!!! I'm thinking that due to TEFRA, the doctor received the max contribution in previous years(20%) and that his employees should have received 25% rather than 20%.

Anyone else run into a similar situation? Is this heading to a VCP filing? Amended returns, etc.???? The plans 2006 restated plan doc. as well as past docs have always reflected the business entity as an LLC taxed as a corporation.

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Sounds like a VCP would be in order to correct this tangled web.

Not that it helps you now, or maybe at all, but in some states, like mine, corporations are not allowed to practice medicine. So when a doctor says he or she is a corporation, that should always be questioned because it cannot be the case. May not be the case in your state, though.

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Guest mjb

JUstme: What is the erroneous calculation that needs to be corrected? There is no prohibition against making a contribution of less 25% of covered comp for the common law employees of a sole proprietorship. 20% of comp/NE for all participants is a nondiscriminatory contribution rate.

Also almost all states permit Drs/attorneys to form PC (Professional Corp) which have the attributes of corp for tax purposes but do not permit limitation of liability for malpractice.

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I haven't seen all the numbers, but it appears that the original poster determined that as a corporation, the allocations were incorrect. VCP would be the way to fix this since it's likely not insignificant.

You are right about a P.C. What I have run into is doctors thinking they are part of a regular (not a P.C.) corporation, in violation of the state's "corporate practice of medicine" prohibitions. It usually turns out that either the doctor didn't know it was a P.C., or it wasn't a corporation after all. Just something to be extra sure about before running contribution calculations.

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mjb: 20% is non-discriminatory for common employees, but as a sole proprietorship and with the TEFRA factored in, the doctor received 20% or $42K and the NHCE's received 20%. TEFRA states the max that can be contributed to self employed is 20% not 25% and if 20% is allocated to the sole proprietor, 25% must go to NHCE's. correct?

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What provisons are you referring to? 401a4 only requires that contributons not discriminate in favor of HCE eg. that owner get a larger % of comp than NHCEs. If the owner receive the same contribution % as NHCEs there is no violaton of 401a4.

The deduction rules uder 404a limit the max deduction for HCEs to 20% of net earnings for self employment. Deductions for NHCEs cannot exceed 25% of covered comp. Deductions of 20% for both groups is permitted under 404a.

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mjb, what you're saying is true but irrelevant to the situation. They allocated contributions under a formula* and used the wrong comp (too high) for the owner because it should have been reduced by the contributions.

*I think it was a formula, but it's not stated. If the plan uses group allocations then they could be ok.

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Bird: where does Loris post say that? The post states that all participants including the self employed DR recieved contributions based on 20% of comp. In 2005 the DR received the 42k max which would have been based on 210 of net earnings and DR comp exceeded a17 limit. In 06 the Dr has 212k. I thought the Q is whether the contribution rate for non HCEs should have been 25% b/c the Dr recieved the max contribution rate of 20% for Self employed persons. I dont understand what you mean by reduced for contributions. If 20% of each participants comp is allocated as a contribution to the plan the formula is nondiscriminatory.

Lori should clarify her Q.

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mjb, I thought Lori H was saying that reported comp was 210,000 in 2005, and they treated it as if was a salary and allocated 20%. You're right that it needs clarification, because there are a couple of scenarios:

-net earnings from self-employment were more than 210,000 but less than (roughly) 252,000 (after contributions for employees). In this case (that's what I assumed, maybe incorrectly) then there was a calculation error because an incorrect figure was used for "compensation."

-net earnings from self-employment were more than (roughly) 252,000. In this case, then there's no problem; earned income after contributions is greater than 210,000 and the correct figure was used.

I could be wrong, but I don't think the Code states a limit of 20% anywhere. The deduction limit is 25% of compensation, which is earned income (after contributions) for a self-employed person. Mathematically that's 20% but that should never, IMO, be used directly in any calcs, except perhaps for the simplest of one-man plans and then only as a shortcut.

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IRC 401©(2)(A) defines earned income for SE person as including the deduction allowed by IRC 404. Pub 560 @ page 21 illustrates how the 20% max contaribution applies.

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Thanks for the replies and sorry if my posts are lacking. The staffs salaries for 2005 py were 71,823. They received a total allocation of 14364.60 or 20%. The census info for 2005, keep in mind we were under the assumption it was an LLC taxed as a corp, stated the doctors comp at "over 210,000". Now that we know that he is actually self employed and let's say his net income AFTER self employment taxes just happened to be 210,000 or higher, then the formula for his contribution in order to max out would have been (.25)/(1.25) X 210,000 or 42,000 and the staff should have received 25% of pay or 17955. Yes?

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Guest mjb

rather basic Q- what was the formula for contributions under the plan? If it is 20% of comp/Self employment income it is non discriminatory. There is no requirement that contribution % for hces must be 25% of comp if self employed owner receives 20% of net earnings. 20% limit for self employed is for deduction purposes only, not qualification.

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Now that we know that he is actually self employed and let's say his net income AFTER self employment taxes just happened to be 210,000 or higher, then the formula for his contribution in order to max out would have been (.25)/(1.25) X 210,000 or 42,000 and the staff should have received 25% of pay or 17955. Yes?

No. You really need to step back and think about this a different way, I think. Forget about 20% as a "maximum." You're not trying to calc a maximum, you're trying to determine 20% of his compensation. I'm guessing that the contribution is pro-rata; you need to say if that's correct or not. You've said that the employee contributions were 20%, and I'm guessing that his net earnings from self-employment, which are over 210,000 but we don't know by how much, have already been reduced by the employee contributions. (I prefer to get net earnings from SE before ANY contributions and then do those calcs myself, FWIW.) We don't have enough information to calculate his contribution, but...

if his net earnings from self-employment after SE taxes but before his own contributions are $252,000 or greater, then a contribution of $42,000 is correct. Subtracting $42,000 from $252,000 gives a net compensation of $210,000 or greater, and 20% of that is $42,000.

if his net earnings from self-employment after SE taxes but before his own contributions are less than $252,000, then your formula is CONTRIBUTION = (SEINCOME - CONTRIBUTION) X 20%. That boils down to CONTRIBUTION = 16.67% X SEINCOME. If self employment income = 225,000, then the contribution is $37,500. (225000-37500=187500; x 20% = 37500)

You seem to want to start with 210000 and then apply 20% to get a "maximum" but that's not right. If his SE income just happened to be 210000, then, yes, the max would be 20% of that. But then as you note, that's really 25%, and the employees didn't get that much. But you can't just give them another 5% because those contributions reduce his SE income. That's why you should start with SE income before ANY contributions and before SE taxes.

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Bird: See Pub 560 P21 (2005) for IRS formula for deducting contributions from net earnings for self employed persons. Under steps 5 and 6 of Pub 560 if net earnings exceed 210k (e.g., your example of 225k), max contribution is 45k (20%x 225) before reduction to 42k max under 415 in Step 8. The contribution is not subtracted from net earnings from SE before multiplying by the contribution % rate. Please provide authority for the proposition that under IRC contributions are subtracted from net earnings from self employment if the net earnings exceed the 401(a)(17) limit.

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I'm with Bird on this one. Of course it depends on how the plan is drafted, but just about every one I've seen defines "Plan compensation" as NE from SE less 1/2 FICA less amount attributable to contribution on behalf of SP, in the case of a DC plan (it is basically the same thing for a DB plan, but the amount attributable/on behalf of the SP is an actuarial calculation that has no definitive formula - but since this IS a DC plan, the above formula holds).

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mjb, the Pub is giving a shortcut for people who don't do plan admin for a living. I do, so I don't use it. You're right, you do NOT subtract the contribution if you're going to use their adjusted rates, they came up with those rates by factoring in (algabraically subtracting) the contribution, as I did above. I showed how a 20% contribution rate on "net" earned income (AFTER subtracting the contribution) is equivalent to 16.67% of gross. The IRS Pub agrees.

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I'm obtaining the 2005 return for this doctor from their cpa. I am of the opinion the staff did not receive their fair share of contribution for "x" amount of years. a 20% allocation to the staff would equate 16.67% to the SE under TEFRA, so as a possible solution, how about allocating a portion of the SE account balance to the staffs and go back as far as the Statute of Limitations allows?

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... but just about every one I've seen defines "Plan compensation" as NE from SE less 1/2 FICA less amount attributable to contribution on behalf of SP...

Another thing to look for. The contributions for the employees should be deducted on Dr.'s Schedule C reducing his NE from SE. His contribution should be deducted on his 1040.

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Guest mjb
I'm obtaining the 2005 return for this doctor from their cpa. I am of the opinion the staff did not receive their fair share of contribution for "x" amount of years. a 20% allocation to the staff would equate 16.67% to the SE under TEFRA, so as a possible solution, how about allocating a portion of the SE account balance to the staffs and go back as far as the Statute of Limitations allows?

Lori: On May 9th you stated that the staff received an aggregte contribution of $14,365 which was 20% of the total staff salaries of 71,823 which would be equal to a 20% contribution (42k) for the owner based on comp of 210K. You asked if the staff contributions should have been 25% of comp instad of 20%. In your orginal post you stated that the contribution for the Owner was 42k which was 20% of 210k in net earnings which exceeded the 401(a)(17) limit.

Q1 Why do now believe that the contribution for staff was only 16.67% instead of 20%?

Q2 what is the accountant's position on the contribution %. After all he filed the tax return for the sponsor.

Mike: Does it really matter how the formula is semantically defined in the plan if the actual contribution is correctly made? I have not seen any Ptype plan documents which use an algebraic formula for PS contributions for SE that Bird believes is necessary. The adoption agreement merely require a nondiscriminatory contribution which will be achieved if the % of comp contributed for the SE person is the same % for the staff which Lori indicated was 20%. If the Net earnings from SE less 1/2 fica exceed the 401(a)(17) limit the max contribution will always be 20% of the a17 limit regardless of how the formula is described.

If the contributions for both the staff and the SE person was 20% of either comp or net earnings of 210 as Lori previously stated what is the evil?

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I'm obtaining the 2005 return for this doctor from their cpa. I am of the opinion the staff did not receive their fair share of contribution for "x" amount of years. a 20% allocation to the staff would equate 16.67% to the SE under TEFRA, so as a possible solution, how about allocating a portion of the SE account balance to the staffs and go back as far as the Statute of Limitations allows?

Q1 Why do now believe that the contribution for staff was only 16.67% instead of 20%?

I did not state that, the STAFF received 20% and the TEFRA equivalent to self employed is 16.67%.

After obtaining his 2005 1040, line 22 TOTAL INCOME was 270,548 from that he deductions of 8881 self employment tax, $42K his p.s. allocation, and $1220 self employed health ins. total AGI of 218447. Incidentally, they deducted 18,792 as pension and annuites line 16a which is 4428 higher than what was actually allocated.

The accountant takes the numbers used in allocation illustrations and uses them in the return. Why there is a 4428 discrepancy, I am about to find out.

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Guest mjb

Lori:

You need to have the accountant or a tax advisor review this or use the calculation in Pub 560 P 22 to determine the proper contribution. Self employment income for retirement plan contributions is taken from line 31 of the schedule C or Box 14 Code A of the schedule K-1 ( form 1065), not line 22 of the 1040 which is total income from all sources including investments or the amount of AGI on line 37. Also line 16a refers to taxable distributions from a retirement plan or IRA, not employer contributions to the retirement plan for staff employees which is deducted on the schedule C. The amount of the health ins deduction is not included in the calculation to determine net earnings from SE.

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mjb, if the only different is semantics, then all is well. It is when there is a legal difference when things start to go sideways. But I'm convinced that you have stated the correct calculation. It is the OP who is having trouble with this, not you.

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Based on the numbers provided, I don't think there was a problem with the allocations. You want the doc to get 20% of his plan compensation*, since that's what the staff got (again, assuming that this is a pro-rata allocation). Start with 270k, subtract half of SE tax, and subtract the (assumed/desired) plan contribution of 42k and you're over 210,000, so you use 210000 and multiply it by 20% and get 42,000. All is well.

*Again, plan comp is net earned income after all contributions have been subtracted. In this case it's capped at 210,000. If his net would have wound up at less than 210, then you'd have to use the 16.67% equivalancy from the pub to calc the contribution, using his "gross" income (i.e. before subtracting his own contribution).

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Lori:

You need to have the accountant or a tax advisor review this or use the calculation in Pub 560 P 22 to determine the proper contribution. Self employment income for retirement plan contributions is taken from line 31 of the schedule C or Box 14 Code A of the schedule K-1 ( form 1065), not line 22 of the 1040 which is total income from all sources including investments or the amount of AGI on line 37. Also line 16a refers to taxable distributions from a retirement plan or IRA, not employer contributions to the retirement plan for staff employees which is deducted on the schedule C. The amount of the health ins deduction is not included in the calculation to determine net earnings from SE.

MJB

You are correct, the schedule C DOES report the correct staff reduction of 14365. Line 31 on the Sched C reflects "Net Profit" of 337975, but when the calc of the SE Tax they reduce Line 31 by 91501 in a "Nonpassive Loss" from his K-1 and calc the SE tax on 246474. I'll refer to Pub 560 to see what I might be doing wrong, but I have an illustration of a 25% money purchase pension plan. In it it shows gross income of $250,000 various expenses totaling $157,500 of which $75,000 is staff salaries and $18750 as staff contribution or TWENTY FIVE%. Therefore the earned income before SE contribution is $92500, one half of SET is 7076 which leaves 85,424 and the illustration calculates the SE contribution as (.25/(1.25)x85424 or 17084 which is 20% of 85,424. So the staff got 25% and the SE got 20%. I understand that this is a MPP example, but what am I missing???? everything??? :blink:

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Lori, the owner in the example you cite is NOT getting 20%. He is getting 25% just like everyone else. They're showing an income BEFORE contribution of 85,424 and applying 20% to determine his contribution of 17084. Subtract that from his "gross" income and you get net earned income after all contributions of 68340. THAT is his plan compensation. Multiply it by the same 25% that everyone else received and you get 17,085. As I noted earlier, his (the owner in the example) contribution is NOT 20%, it is 25%. 20% is simply an algabraic shortcut to apply against his "gross" income.

Your doc's gross (after all expenses and 1/2 SE tax but before his own contributions) is somewhere around $266,000. Using the shortcut of 16.67%, the equivalence for a 20% contribution, you get a number greater than $42,000. So his contribution is $42,000.

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