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Definition of "Earned Income"


Gary Lesser
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It does not appear that the Small Business Jobs Act of 2010 (SBJA) changed the definition of “earned income” for retirement plan purposes. A temporary provision allows self-employed individuals who claim a deduction for health insurance premiums to reduce their earnings for self-employment tax purposes (SBJA § 2042, IRC 162(l)(4)) for one year. However, the SBJA did not change the definition of earned income for retirement plan purposes found in Code Section 401©(2) referring to and making adjustments to IRC 1402(a), net earning from sef-employment. The Technical Explanation of the Tax Provisions in the Senate Amendment 4594 To H.R. 5297 prepared by the Joint Committee on Taxation states that "It is intended that earned income within the meaning of section 401©(2) be computed without regard to this deduction for the cost of health insurance." The explanation indicates that "A technical correction may be needed to achieve this result."

For example, if net earnings from self-employment under IRC 1402(a) is reduced by the health insurance premium amount, then it would have to be added back in calculationg EI under 401©(2)--which it isn't--for the intended result to be achieved. As inteneded, earned income under 401© should not be reduced by the health insurance premium--thus, allowing higher contributions.

Law (enrolled version), available at: http://thomas.loc.gov/cgi-bin/query/D?c111...p/~c111DFUn1V::

Official Explanation, available at: http://www.jct.gov/publications.html?func=...own&id=3707 See pages 22-23.

Note. The SPJA also created "internal" rollover conversions into DRA portability for 401(k), 403(b), and 457 governmental plans (see Explanation pages 39-43) and provisions for partial annuitization for certain nonqualified annuity contracts (see Explanation pages 44-46). It is unclear to what extent the new "internal rollover" provisions will apply to governmental 457 plans before 2011 (which may affect the ability to spread conversion income to 2011 and 2012 with a "2010" internal rollover to a DRA. The rollover provisions are effective sooner that the ability to have a DRA in a governmental 457 plan.

Hope this helps.

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