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SECURE 2.0 Deduction for Roth employer contributions


Ian

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For 401(k) plans that decide to allow Roth employer contributions, how, if at all, will the deduction rules change for those contributions? I'm thinking that traditional employers will still get a deduction, but what self-employed plan sponsors? Will it depend on the way the self-employed business is structured?

Thanks for any thoughts.

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Hmm, interesting question! Just off the top of my head, I'd guess that the contribution calculation will remain the same, but the DEDUCTION on the 1040 will be reduced by the amount of "employer" Roth profit sharing/match contributions made on behalf of the self employed owner/partner. Obviously not sure - I hadn't even thought about this question. Some of the CPA types on this board are likely to have a much more informed opinion!

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To keep things on an equal footing I would expect the employer takes a deduction for the Roth contribution and the employee would be taxed on the amount of the contribution as if they had been paid that amount.  It should be the same as if the employee gets paid by the employer and then the employee made their own Roth contribution. 

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What's the reporting on it?

Does the plan issue a 1099-R for ROTH contribution or is it added to the employee W-2?

If added to the W-2 do they code it to be exempt from payroll taxes?

If on the W-2 how is it reported to SE who don't get a W-2?

Is it income for the employee taxable year when deposited or for the year declared?

If it shows up on the w-2 how do you make sure it doesn't become circular if the definition of comp is W-2 wages?

Maybe these questions have been answered and I missed that recap.

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Roth employer contributions were made effective as of the date of enactment of SECURE 2.0 - so a plan could have allowed them for 2022. I'm sure somebody, somewhere out there took advantage of it in the 2 days between the passage of SECURE 2.0 and the end of the year. That person presumably has an income tax return due in about 2 and a half months from now - moreover, their employer has to get them a W-2 and/or a 1099 within the next few days - and there is no guidance on how those contributions should be reported. I really can't blame the IRS on this, given the timing of the law. But it does make the reporting question kind of urgent.

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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I am going to speculate here, but I think they would still get the deduction for the contribution, so it would still have the effect of reducing their net earned income for pension purposes. However on their tax return, the fact that the contribution is included in current income would have the effect of cancelling out the deduction. It would be like if they made a contribution and took a distribution in the same year. Or more on point, if they made a contribution and did an in-plan Roth conversion.

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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Point of interest: Assuming business takes deduction but sole proprietor (for example) includes in current income, will adversely affect the permanent 20% QBI deduction for taxpayers who otherwise qualify for the deduction in whole or part.

 

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The provision was added ostensibly to make it convenient for a participant to convert match and NEC contributions to Roth without having to do an in-plan conversion.

It would seem logical - and that certainly is not a deciding factor on how this shakes out - that the taxation would parallel what currently is done for in-plan conversions.

If so, then the company would not be involved other than to make the company contributions as they always have done.  The plan recordkeeper would collect an election from the participant to treat the company contribution as Roth and also an election on whether income taxes would be paid out of the participant's account.  The plan recordkeeper would know the participant's vested status and the amount of the contribution.

The plan would report the taxable amount to the participant on a 1099R Code 2 (no 10% early withdrawal penalty).  The amount would be taxable based on the date of the conversion which would be around the time the employer contribution was posted to the participant's account (not the plan year associated with the contribution).

Withholding is optional, so the participant would need to either pay estimated taxes, or up their withholding from wages.  If plan allows, the participant could an in-service withdrawal but that would be taxable and possibly subject to the early withdrawal penalty.

Note that the company would not have to pay payroll taxes on these Roth amounts, and the Roth amounts would not affect compensation used by the company's other benefit plans.

For self-employed individuals, the year of taxation of the Roth amount would depend upon the date the amount was funded to the plan.  Note that the Roth amount would  be considered as taxable income from the qualified plan and not be considered as taxable self-employed income.

Thoughts anyone?

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19 hours ago, Paul I said:

Thoughts anyone?

I think you hit many of important questions here.

  1.  I agree that it would be income rather than compensation, so it will not affect plan compensation or payroll taxes
  2. It makes sense to tax in the year of contribution rather than the year of allocation.  Otherwise you could run into issues where the contribution is decided on months after a participant files his or her taxes for the year of allocation.
  3. Plan assets for withholding...  probably limited to instances where the participant is otherwise eligible to take an in-service distribution to prevent leakage.

 

 

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