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emmetttrudy

DB/DC Contribution Limit

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A sole prop has a 401k PSP for 201 and has already contributed his maximum deferral of 17,500 and PS of $33,500. Now he would like to implement a DB Plan in 2014. If he does this, his PS contribution would be limited to 6% based on the combined deduction limit, but he's already contributed more than this.

How to fix this, if possible?

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That isn't the way it works. In your situation, his combined limit for both plans would be 31% of compensation. It is really a 25% limit, but he first 6% doesn't count.

See IRC 404(a)(7)

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Speaking as a humble taxpayer and not as a practitioner dealing with sole proprietor plans, if I understand the situation correctly, his PS contribution would not actually be limited more than is permitted under the deferral rules, but the extent to which his contributions are tax deductible might be. Not quite the same thing. Perhaps the tax rules are intended to keep people like your sole prop from stashing too much away on a tax-favored basis. It used to be the case that contributions and/or benefit accruals were subject to a hard limitation on a combined basis under IRC 415 but I believe that to no longer be so.

I leave it to people who do work with sole proprietor plans to make suggestions as to how to optimize his contributions relative to the deduction limits. Perhaps he should hold off on establishing the DB plan until 2015 (and coordinate his 2015 PS and DB contributions accordingly) or establish a DB plan small enough to keep things deductible this year and then improve it next year. Or pay some taxes.

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Effen - right, i understand the combined deduction rules, but the way it's going to pan out, given the amount he'll contribute to the DB Plan, hisPS won't be able to be $1 more than 6%.

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one thing we thought of doing was to design the DB formula so that his DB conribution is limited in 2014, and he stays within the deduction limit. and then it increases in year two so he can put a significantly higher amount in the DB Plan + the 6% profit sharing.

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Maybe this has been addressed, but perhaps the sole proprietor might hire an employee and provide coverage for that employee in these plans.

If the sole proprietor is a farmer (or insome other "field" that is not exempt automatically from PBGC coverage), then covering this employee now requires the DB plan to be covered by the PBGC and the IRC 404(a)(7) combined plan deduction limit is thus vanquished. Add slain dragon icon.

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If the sole proprietor is a farmer (or insome other "field" that is not exempt automatically from PBGC coverage),

I see what you did there...

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...then covering this employee now requires the DB plan to be covered by the PBGC and the IRC 404(a)(7) combined plan deduction limit is thus vanquished.

Where we presume the other employee is not the spouse.

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That isn't the way it works. In your situation, his combined limit for both plans would be 31% of compensation. It is really a 25% limit, but he first 6% doesn't count.

See IRC 404(a)(7)

Effen, why 31%? What if the DB amount is more than 31%. Wouldn't that DB limit apply?

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Here's how 404(a)(7) looks to me:

If the Employer contribution made under the defined contribution plan exceeds 6% of eligible compensation, then 404(a)(7) kicks in. That makes the combined plan deduction limit 25% of eligible payroll but with the first 6% going into the DC plan ignored. Thus getting you to the maximum deduction of 31% of eligible compensation assuming something over 6% was the DC plan deductible contribution.

If the DB contribution takes you over the 31%, then you have nondeductible contributions and the consequences that apply to making such a nondeductible contribution.

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Here's how 404(a)(7) looks to me:

If the Employer contribution made under the defined contribution plan exceeds 6% of eligible compensation, then 404(a)(7) kicks in. That makes the combined plan deduction limit 25% of eligible payroll but with the first 6% going into the DC plan ignored. Thus getting you to the maximum deduction of 31% of eligible compensation assuming something over 6% was the DC plan deductible contribution.

If the DB contribution takes you over the 31%, then you have nondeductible contributions and the consequences that apply to making such a nondeductible contribution.

Thanks John- That is what I thought at first. Then I read the explanation from the technical corrections to PPA 06. It says, in part:

"If an employer sponsors one or more defined benefit plans and one or more defined contribution plans that cover at least one of the same employees, an overall deduction limitation applies to the total contributions to all plans for a plan year. The overall deduction limit is generally the greater of (1) 25 percent of compensation or (2) the amount necessary to meet the minimum funding requirement of the defined benefit plan for the plan year. " This seems to say that if the amount necessary to meet the DB funding requirement is -say $150,000, that would be the prevailing limit, since it is greater than 25%.

I agree that the rule kicks in only if the DC contribution exceeds 6%, and that the first 6% is ignored if the DC contribution exceeds 6%. But, doesn't the above make the 25% the limit, only if it is greater than the DB required funding amount?

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The DB minimum is, of course, deductible. I should have noted that.

Look at Q&A 8 of Notice 2007-28:

Q-8. How does the combined limit of § 404(a)(7) apply when employer contributions to defined contribution plans (other than elective deferrals) exceed 6 percent of compensation of participants in those plans?

A-8. When employer contributions to defined contribution plans (other than elective deferrals) exceed 6 percent of compensation of participants in those plans, the amount of employer contributions to defined contribution plans to which the combined limit of § 404(a)(7) applies is equal to the amount of employer contributions for the plan year less 6 percent of compensation of participants in those plans. Thus, the combined limit of § 404(a)(7) (i.e., the greater of 25 percent of compensation, or the contributions to the defined benefit plan or plans to the extent such contributions do not exceed the amount necessary to satisfy the minimum funding standard for the defined benefit plans, treating a contribution that does not exceed the unfunded current liability as an amount necessary to satisfy the minimum funding standard for each defined benefit plan) applies to the total of employer contributions to defined benefit plans and employer contributions to defined contribution plans (other than elective deferrals), less 6 percent of compensation of participants in the defined contribution plans.

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DB plan not covered by PBGC. No DB contribution for year since close to being fully funded.

For the 401(k) PS plan, client can deduct 25% of compensation or 31%?

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The DC plan limit is still 25% of eligible payroll for the employees covered by the DC plan. Deferrals do not count in that, of course. Voluntary after-tax contributions also do not count against that limit either.

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