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Partners in 401(k) Plan and Maximum Contribution allowed


Alex Daisy
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This question is related to a 401(k) Plan with many partners and rank and file employees and not to a Solo SEP or 401(k) with 1 partner.

For the 2018 Plan Year:  After i calculated a maximum Contribution (employee deferrals, Safe Harbor 3% NEC, and Employer Profit Sharing for a partner as $55,000, their accountant is telling me that the partners maximum Contribution should be limited to 20% of their reduced K-1 income, which comes to approximately $50,000.

I have found information about the maximum contribution for self employees individuals to be limited to  20% of their reduced K-1 income, but does this apply to 401(k) Plans? and not just to SOLO SEP'S and 401(k)'s with 1 employee (the partner)

Any guidance is greatly appreciated

Alex

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It sounds like the accountant is conflating different rules that might apply to a one person plan but not even getting that part right.  

The overall deduction limit for profit sharing is 25% of total compensation (for all covered employees, not for each partner - Section 404).  If you had a one man plan for a self employed individual, yes, the maximum profit sharing contribution would be (roughly) 20% of net self employment income since that is equivalent to 25% after contributions.  But each individual is limited to the lesser of $55K or 100% of pay (Section 415).  The accountant is applying 25% to the wrong limitation.

Let's take a scenario similar to yours, but for a one-man plan and a partner or sole prop with $250K of net self employment income (let's assume it has been reduced by the deduction for 1/2 of SE taxes and any other necessary but unlikely adjustments).  The maximum profit sharing is 20% of that or $50,000, but the maximum total contribution is $55K (plus catchup if applicable) so there is room for some 401(k) contributions to max out.

Accountants don't tell us how to allocate contributions, we tell them.

 

Ed Snyder

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I agree with Bird. I've also had this conversation with accountants before. If they are used to dealing with one-person businesses, the fact that one partner could have a contribution exceeding 20% never comes up. But any accountant used to working with slightly larger businesses should become familiar with the rule. 

Just having an employee can create this issue, even for a one owner plan sponsor. 

If a two person plan (one owner, one NHCE) and the owner gets a contribution of $50,000, but self- employment compensation is only $150,000 for the Owner, that might be okay. The NHCE might be getting a PS of $5,000 (say comp is $70,000) So total ER is $55,000, which is 25% of $220,000. Allowed as long as it passes testing. Even though the owner's PS is 33.3% of comp. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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No. Each partner's deduction for his or her own contribution is determined individually, and cannot exceed 25% of his or self-employment income on K-1, minus 1/2 SE tax, and minus the contribution itself, resulting in a circular calculation. See IRC sec. 404(a)(8)(C) and Temp. reg. 1.404(e)-1(A). You deduct the contributions for employees on the 1065, and that is shared by the partners in the same percentages as they share general business expenses. Then you have to calculate each partner's deductible amount separately. (Each partner will have an individually allocated contribution amount, typically, if, e.g., cross-testing is used to determine contributions.) Again, the deductible contribution for each individual partner is limited to 25% of his/her SE income, as reduced by half of his/her SECA tax, minus the contribution itself that is being deducted. You can use algebra (or Excel) to calculate x = .25 * (SE income - x), but the description of the calculation in Pub 560 is basically correct, since 25% is 20% of 125%.

P.S. Don't forget to check whether each individual partner took a deduction for unreimbursed partnership expenses on Schedule E, since that reduces his/her SE income.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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13 hours ago, Luke Bailey said:

Again, the deductible contribution for each individual partner is limited to 25% of his/her SE income, as reduced by half of his/her SECA tax, minus the contribution itself that is being deducted.

I followed your cites and have to admit I am not the best at reading/interpreting the code and regs, but I don't see contributions limited to 25% for each partner.  And Pub 560 specifically says 25% of all participants' compensation.  Hope to get some other opinions on this.

image.png.422d5f71bbdd48ab8fcb194bc527701c.png

Ed Snyder

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3 hours ago, Bird said:

I followed your cites and have to admit I am not the best at reading/interpreting the code and regs, but I don't see contributions limited to 25% for each partner.  And Pub 560 specifically says 25% of all participants' compensation.  Hope to get some other opinions on this.

image.png.422d5f71bbdd48ab8fcb194bc527701c.png

Bird, what? Other opinions? :)

Read footnote 1 in the table you excerpted and then follow to the "Deduction for Self-Employed Individuals" discussion in the right-hand column on page 15.

But of course, the more crucial cites are to the Code itself (404(a)(8)(C)) and regs (Temp. reg. 1.404(e)-1(A)).

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Hmm. I'm not a CPA, but I would think after years in this business this wouldn't be the first time I've heard of this. But I do learn new things all the time. 

§404(a)(8)(C) - to me this just says contributions can't exceed earned income. Okay, makes sense. 

For Reg 1.404(e)-1A

https://www.law.cornell.edu/cfr/text/26/1.404(e)-1A

Where does it limit the individual partner's deductible amount? If anything it seems to read that the amount deductible (not the 25% deduction limit itself) under the 25% limit replaces the the regular limitation for a self-employed individual. But admittedly I've only skimmed this cite. 

Publication 560 https://www.irs.gov/pub/irs-pdf/p560.pdf

I agree with Bird on how that pub reads. 

I feel like this would be common knowledge if true. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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I realize that the IRS's examination guide does not control / is not precedent, but it is helpful to know what an examiner would use to guide them, since it shows how they might interpret the rules.

https://www.irs.gov/irm/part4/irm_04-072-015

At one point it describes the excess for a self-employed individual as the amount that exceeds 100% of their earned income. If the limits were applied the way Luke describes, it should describe the excess as the amounts over 25% of their earned income. 

See also

image.png.e23974ac0eef5b5a9ca67d487f0a3450.png

Wouldn't it be clear that the limit applies to the individual, not the employer if that's how it should be applied? 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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2 hours ago, justanotheradmin said:

image.png.5f8c7c23eea9b013b5f0c9209c3b9e43.pngthis discussion from page 15? It mentions the circular calculation, which I do pretty regularly, but not a 25% limit per partner. 

 

I always thought it worked the way Luke indicated, and this is confirmed by language quoted above from Pub 560. Both "self-employed individual" and earnings from self-employment (and earned income) are defined earlier in that Publication. For example:

"Self-employed individual. An individual in business for himself or herself, and whose business isn't incorporated, is self-employed. Sole proprietors and partners are self-employed."

And "earned income" as used 404(a)(8)(C) is defined in 404(a)(8)(B) by reference to 401(c)(2) (net earnings from self-employment).

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I don't think there is any disagreement about who counts as self-employed, or even what earned income is. 

The question is more where a self-employed individual is allocated an employer contribution that is larger than 25% of earned income, is the individual's deduction for their own contribution limited to 25% of the individual's income? Or does the plan deduction limit of 25% apply?

This is assuming the allocated employer contribution otherwise meets the total plan deduction limit of 25% (under 404), and any other regular individual participant limits such as 415. 

Based on my reading of Reg 1.404(e)-1A the regular deduction limit for a self-employed individual is replaced by the amount deductible as an employer under §404. If i'm misunderstanding that reg, I'm hoping someone can point to the specific language and break it down for me. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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Thanks, card. I'm finding there is surprisingly little that explains this, at least from IRS. I recall that Derrin Watson did a 90-minute webinar on the issue, maybe 6 or 7 years ago, but cannot find it on internet and won't even begin to search my office. I don't recall what his position was on it, though I'm sure it was correct.

The statutory basis for the position I originally advanced is 404(a)(8)(D), which says that for a self-employed person (which would include both sole proprietors and partners), you treat all references to "compensation" (which would seem clearly by its terms to include the 25% of "compensation" limit of 404(a)(3)(A)(I)(I)) as being references to "the earned income of such individual derived from the trade or business [of the plan sponsor]."  Close to unambiguous, but maybe not completely unambiguous.

I am having difficulty marshaling support one way or the other from the regs, and would note (a) that the regs are out of date, and (b) they (and 404(a)(8)(C)) provide that the amount does not fail 162 or 212 as long as not in excess of all earned income, but that's not conclusive for the 25% of compensation limit of 404(a)(3).

Treating each partner individually seems clearly implied by Pub 560, unless you assume that Pub 560 assumes only a sole proprietor and the IRS just didn't think to tell us in Pub 560 that if we're dealing with a partnership the 25% rule is applied to all of the partners as a group.

I'm also having trouble figuring out how anything other than an individual calculation would work mechanically in terms of the partner's return preparation. The preparer who does the Firm's 1065 deducts the plan contributions for the W-2 employees on the 1065, and that deduction reduces all the partners' gross income from the partnership's trade or business as reported on each individual partner's K-1. Then you get your K-1, and it does not have on it a deduction for your own contribution. You have to take your deduction on line 28 of Schedule 1 for 2018. (Before 2018, was just line 28 of the 1040, but now on a separate schedule due to "simplification.") But I've never seen the preparer of the 1065 and K-1's tell you that they ran the 25% deductibility test on the aggregate of all the partners and you're contributions are OK, or not, globally. Frankly, they really don't know your earned income, because as I mentioned yesterday, some partners may take an additional deduction on schedule E for unreimbursed partnership expenses. I believe the preparers' software tests at the individual level. (Hence, I guess, the original questioner's disagreement with CPA, although not proof of who's right, of course.)

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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My understanding has always been the same as that of Bird/just: the deduction limit is 25% of total eligible compensation for the plan, and the only other limit the partner has to worry about is their 415 annual additions.

For what it's worth, EOB is very clear on this -- I hope I'm not breaking any rules by posting the paragraph verbatim here:

Quote

Effect of aggregate limit under IRC §404(a)(3). Since the deduction limit under IRC §404(a)(3) is based on the aggregate compensation of all “beneficiaries” under the plan, the sum of the earned income of the self-employed individuals benefiting from the plan plus the compensation of any employees benefiting from the plan is taken into account to calculate the 25% deduction limit. Some practitioners make the mistake of assuming the 25% deduction limit applies individually to each self-employed individual, particularly if the plan is maintained by a partnership and more than one partner benefits under the plan. This is simply not true. There are only two limits that might affect the deduction that can be taken with respect to allocations of employer contributions on behalf of a self-employed individual: (1) the IRC §415(c) limit, as discussed in Section II of Chapter 5, and (2) the limit under IRC §404(a)(8)(C), which provides that the amount deductible with respect to contributions made on behalf of a self-employed individual may not exceed 100% of the individual’s earned income (determined before the deduction). Also see 11. below regarding this issue, where a specific example is given that shows one partner receiving an allocation in excess of 25% of earned income.

 

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duckthing, the analysis in the EOB (which I don't have, so cannot consult, and appreciate your posting)could be correct, but to the extent it cites nothing but the statute, I can't conclude it is definitely correct. The EOB analysis glosses over the "of such individual" clause in 404(a)(8)(E), and assumes it is not intended to be taken literally, just as a sloppy way of saying that the self-employment income of the partners (in the aggregate) is to be lumped in with the employees' W-2 comp as "compensation." But Congress could have referred to self-employed individuals, plural, in 404(a)(8)(E), and they didn't. It is possible to interpret that as unintentional, but you can also interpret it as intended to treat each individual partner separately, and that interpretation seems consistent (although not unambiguously so) with Pub. 560.

Boy do I wish I had Derrin Watson's Powerpoints on this.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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20 minutes ago, Luke Bailey said:

But I've never seen the preparer of the 1065 and K-1's tell you that they ran the 25% deductibility test on the aggregate of all the partners and you're contributions are OK, or not, globally. Frankly, they really don't know your earned income, because as I mentioned yesterday, some partners may take an additional deduction on schedule E for unreimbursed partnership expenses. I believe the preparers' software tests at the individual level. (Hence, I guess, the original questioner's disagreement with CPA, although not proof of who's right, of course.)

I can tell you that it is at this point that in the preparations of a partner's return that I get questions. The occasional CPA will come to me to ask about the 25% aggregate limit and confirm it. But usually we've already supplied the sponsor and their CPA with a copy of an employer contribution breakdown by participant, draft SE tax calc , and draft 404 deduction worksheet for their use. But if the CPA hasn't seen those things and they want clarification most seem to know they can just ask us. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

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Thanks, justanotheradmin. At this point, I have to say I'm an agnostic on this issue. Can see arguments both ways. But if the "aggregate" theory is correct, boy does the IRS need to explain that and change Pub 560 to include situations with multiple owners.

This is really complicated. Perhaps an example will point out the importance of issue. Suppose you had a partnership with two partners and total W-2 compensation of $1 million, and the partnership contributes $100,000 to a profit sharing plan (no 401(k)) for the employees. The partnership also contributes $50,000 for each partner. Assume that the year is not very profitable, and that without the deductions for their own contributions, the partners each have only $50,000 in SE income. Can they each deduct 100% of the contribution for them (because it is not in excess of their SE income and 25% of total compensation is .25 * [$1,100,000 - $100,000], or $250,000, so that the $100,000 for the employees plus the $100,000 for the partners is still within 25% of total compenation), or just $10,000 apiece (25% of [$50,000 - $10,000])? Pub 560, I think, would say the latter, but maybe it is the full $100,000. I don't see anything yet that definitively says one way or other.

For what it's worth, the following from IRS website seems to assume that each individual partner has a separate calculation. However, it is not definitive both because not regs and also may just be repeating the mistake in Pub 560. I mention it primarily because it seems to confirm IRS's belief that the Pub 560 calculation is applicable to partners. To see in context, go to https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-contributions-what-is-a-partners-compensation-for-retirement-plan-purposes. Finally, the below doesn't directly mention the 404(a)(3) 25% of compensation deduction limitation, although it does so indirectly by referring to the calculation in Pub 560. But you could interpret the below as describing how the partnership should calculate the individual partner's contributions for 415(c) and 401(a)(4) purposes, but not limiting the partner's deduction to 25%/20% of the individually calculated amount.

What is a partner’s “compensation” for retirement plan purposes?

A partnership makes annual contributions to a partner’s retirement plan account based on her net earned income.

Net earned income

For a partner, this is calculated in the same way as for most other self-employed plan participants by starting with the partner’s earned income and then subtracting:

  • plan contributions for the partner, and
  • half of her self-employment tax.

Publication 560 has tables and worksheets to calculate the deduction for contributions to a qualified plan for a partner.

Partner’s earned income

A partner’s earned income is the income she receives for her services to materially help produce that income (see Internal Revenue Code sections 1402 and 401(c)(2).) A partner must separately calculate her earned income for each trade or business.

Not every partner may have earned income (for example, a limited partner who does not provide services to the partnership and is merely an investor). Also, all of a partner’s income from the partnership may not be earned income (for example, investment income that is passed through the partnership to the partners).

Additional Resources:

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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OK. Here's another weird thing I just thought of about this, which shows how complex it is. Assuming you do get to use the aggregate method (i.e., employee comp and partner comp are aggregated and you can spread out to the partners, up to their individual contribution amounts, up to 25% of that total amount), you still have to calculate the partners and employees separately, because employees' "comp" number (basically, W-2 with 401(k), 125, and 132(f)(4) addbacks) does not include their nonelective and matching contributions by definition, while for partners you do have to calculate the nonelective and match that each gets and subtract those amounts from K-1 earnings, in a circular calculation, to get their "comp" for plan purposes (401(c)(2)(A)(v)). So you would need to first calculate all of the partners' individual contributions, add them up, and then reduce aggregate 401(c)(1) self-employment income for all partners, before the contributions, by the aggregate partner contributions, then add that number to the employee compensation number, and your overall deductible limit would be 25% of that resulting sum. Even putting aside that this would not be accurate because you would not have included individual partners' unreimbursed partnership expenses (which I think a lot of partnerships, but not all, blow off), I don't know anybody who does that. I think the folks responsible for the partnership's return and for calculating the partnership's retirement contributions and deduction just take the number for the W-2 employees on the 1065 and push the partner calculation out to the individual partners on the K-1 and leave it at that.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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12 hours ago, Luke Bailey said:

So you would need to first calculate all of the partners' individual contributions, add them up, and then reduce aggregate 401(c)(1) self-employment income for all partners, before the contributions, by the aggregate partner contributions, then add that number to the employee compensation number, and your overall deductible limit would be 25% of that resulting sum. Even putting aside that this would not be accurate because you would not have included individual partners' unreimbursed partnership expenses (which I think a lot of partnerships, but not all, blow off), I don't know anybody who does that.

We do.  A long time ago, when I was smarter, I developed a Lotus spreadsheet that literally guessed at the earned income numbers, and then compared those to the calc'd numbers, and zeroed in on the final accurate number, using a macro.  So there were no circular references in the calcs.  Someone smarter than me has converted that to Excel.  I'm told that if you do it in Excel using circular references and just keep hitting F9 it will zero in on the right number(s) but I've never tried that.

Ed Snyder

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19 hours ago, Luke Bailey said:

Read footnote 1 in the table you excerpted and then follow to the "Deduction for Self-Employed Individuals" discussion in the right-hand column on page 15.

Yeah, I see but I guess I'm just gonna say that I think they either tried to simplify it or didn't understand themselves that it is an overall 25% limit.  

Ed Snyder

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30 minutes ago, Bird said:

I'm told that if you do it in Excel using circular references and just keep hitting F9 it will zero in on the right number(s) but I've never tried that.

In Excel go to Options > Formulas and check the box for "Enable Iterative Calculations" to save your F9 finger.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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5 hours ago, Bird said:

Yeah, I see but I guess I'm just gonna say that I think they either tried to simplify it or didn't understand themselves that it is an overall 25% limit.   

Bird, those are two possibilities. The third is that the IRS thinks that is the right way to do it. I can see arguments both ways. Maybe someone who has dealt with IRS at a high level on issue can weigh in. I think either approach would be justifiable under statute.

Luke Bailey

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214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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On 4/10/2019 at 4:53 PM, Luke Bailey said:

the analysis in the EOB (which I don't have, so cannot consult, and appreciate your posting)could be correct, but to the extent it cites nothing but the statute, I can't conclude it is definitely correct.

The EOB section above (Ch 7 - Section XVI - Part H - Item 1) is not the only relevant discussion in Chapter 7.  I think Item 11 of that same Part H gives a better analysis.

Quote

11. Allocation of deduction among partners. Treas. Reg. §1.404(e)-1A(f) prescribes rules for allocating the qualified plan deduction among partners of a partnership that maintains the plan.

11.a. Defined contribution plan. In the case of a defined contribution plan, the amount contributed on behalf of a partner must be allocated to that partner’s distributive share under IRC §704. The deduction with respect to the contribution made on the partner’s behalf is separately accounted for by the partner, and deducted for his taxable year with or within which the partnership’s taxable year ends, as an item described in IRC §702(a)(8). This rule is prescribed in Treas. Reg. §1.404(e)-1A(f)(1). Accordingly, the partnership agreement cannot allocate to a partner any portion of the deduction that is attributable to contributions made on behalf of another partner. For contributions made on behalf of the common law employees, the deduction is allocated in accordance with general allocation rules under IRC §704.

11.a.1) Individual partner’s allocation may be greater than 25%.

When the regulation says that a partner cannot be allocated a portion of the partnership’s deduction that is attributable to contributions made on behalf of another partner, it is not saying that the deduction for an allocation to an individual partner must be supported under IRC §404(a)(3) by taking into account only the earned income of that partner and the compensation of the common law employees covered by the plan. The deduction limit under IRC §404(a)(3) is an aggregate limit that is based on the combined earned income of all self-employed individuals covered by the plan (e.g., all partners covered by a plan maintained by a partnership) and the compensation of all employees covered under such plan. How the total contribution gets allocated is not limited by the 25% limit under IRC §404(a)(3). The allocation to an individual partner cannot violate the IRC §415(c) limit and the amount allocated cannot violate IRC §404(a)(8)(C), which limits allocations to a partner to 100% of his/her earned income (determined before the deduction for the qualified plan contribution made on behalf of the partner). As discussed in the introductory notes to this Part H, since the IRC §415(c) limit is based on current earned income, IRC §404(a)(8)(C) would never be violated with respect to an allocation to a self-employed individual because there would need to be earned income left after the deduction to support the annual additions allocated to the self-employed individual’s account. Thus, one partner might receive an allocation that exceeds 25% of earned income and another partner might receive an allocation that is below 25% of earned income, depending on the plan’s allocation method, yet the deduction for the respective allocations could be passed through from the partnership to the individual partners that reflects the amount allocated to each partner, in accordance with Treas. Reg. §1.404(e)-1A(f)(1). 

11.a.1)a) Example - partner’s allocation exceeds 25% of earned income.

Partnership AB maintains a new comparability profit sharing plan. The plan covers the two partners, Abe and Bridget, and two common law employees, Charlie and Diane. Abe owns one-thirds of the partnership interests and Bridget owns two-thirds of the partnership interests. It is determined that the plan can satisfy IRC §401(a)(4) using the cross-testing method prescribed byTreas. Reg. §1.401(a)(4)-8(b), and it can do so by providingCharlie and Diane a 5% allocation, which satisfies the “gateway” requirement under the cited regulation. Charlie earns $40,000 and Diane earns $20,000 per year. The 5% allocation would result in a $2,000 allocation to Charlie and a $1,000 allocation to Diane, for a total allocation of $3,000. The partners divide the deduction for the common law employees’ allocation using a two-thirds/one-third split, resulting in $2,000 of the deduction allocated to Bridget and $1,000 allocated to Abe. Abe and Bridget’s earned income, after factoring in the allocation of the qualified plan deduction attributable to the common law employees and the 164(f) deduction discussed in 1.c. above, is as follows:

Abe: $180,000

Bridget: $90,000

To solve for the total 25% deduction available under IRC §404(a)(3), the following formula can be used.

x + $3,000 = .25 ($60,000 + ($270,000 -x))

x in this formula is the maximum amount that may be contributed on a combined basis to Abe and Bridget without exceeding the IRC §404(a)(3) deduction limit. On the left side of the equation is the sum of the contribution to be made for Abe and Bridget on a combined basis (x) plus the contribution made for Charlie and Diane on a combined basis ($3,000). The deduction limit is on the right side of the equation, which multiples by 25% the sum of Charlie and Diane’s combined compensation ($60,000) plus the combined earned income for Abe & Bridget after the contribution made on their behalf (x) is subtracted from their pre-deduction combined earned income ($270,000). The solution for x is as follows: 

x + $3,000 = $15,000 + $67,500 - .25x

x + .25x = $15,000 +$67,500 - $3,000

1.25x = $79,500

x = $79,500/1.25

x = $63,600

So, $63,600 is the most that can be allocated on a combined basis to Abe and Bridget. Suppose $53,000 is allocated to Bridget and $10,600 is allocated to Abe. Assume this allocation will satisfy IRC §401(a)(4). The resulting earned income would be as follows:

Abe: $90,000 - $10,600 = $79,400

Bridget: $180,000 - $53,000 = $127,000

Combined earned income: $79,400 + $127,000 = $206,400

The 25% is not exceeded. The total contribution is $66,600 ($53,000 to Bridget, $10,600 to Abe, $2,000 to Charlie and $1,000 to Diane). The combined earned income for Abe and Bridget ($206,400) plus the combined compensation for Charlie and Diane ($60,000) is $266,400. The 25% deduction limit is 25% x $266,400, or $66,600, which equals the total allocation made for the four participants in the plan. In this example, Abe’s allocation was 13.35% of earned income ($10,600/$79,400), while Bridget’s allocation was 41.73% ($53,000/$127,000). Note that, if an allocation of 41.73% to Bridget couldn’t be supported under IRC §401(a)(4), a larger portion of the contribution might have to be allocated to Abe and/or Charlie and Diane, or the partnership might have to consider not contributing the full deduction limit amount.

 

 

 

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I have to say that I'm still agnostic. While you demonstrate that the EOB goes into significant and plausible detail, proving that it does not simply miss the issue, the only authority cited (Treas. Reg. §1.404(e)-1A(f)(1)) doesn't seem to prove or disprove the point. As previously stated, I think an argument can be made that the approach taken by the IRS in Pub 560 is supported by IRC sec. 404(a)(8)(D)'s use of the phrase "earned income of such individual." I think the IRS should clear this up in a Rev. Rul. Probably would not require a regulation.

Luke Bailey

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Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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