Can contributions exceed compensation?

[Guest Bob Monte]

For 2001 for a self-employed person who is the only participant in a 401-k:

If his applicable compensation is $10,000, he can make an employee elective deferral for the full $10,000 and then can make a employer profit sharing contribution of 13.04% of $10,000 giving him a total deductible contribution in excess of his contribution.

This doesn't seem right but I don;t see anything in the IRS pubs that disagrees but then they don't really s. Is this right? the same could occur with a SIMPLE at different compensation levels.

For 2002 when Employer limits go to 100%. could he in effect contribute twice his compensation??? I surely must be missing something but the pubs seem to say that employee deferrals do not affect employer limits for the self-employed.

[mbozek]

Maybe I am missing something but where is the additional cash for the contribution in excess of compeensation coming from? Are you suggesting that the employee contribute out of pocket cash to the plan? Also as an accounting matter I thought the deduction to a DC plan is limited to the amount of compensation paid to the ee for a year.

[Guest Bob Monte]

the extra cash could come form other employment, rental activity, interest, dividends, etc.

I am searching all over. Even the IRS sites and pubs do not seem to clearly explain all this employer and employee limits and calculations procedures for the self employed. Is there some book or article out there that expressly deals with this?

[Belgarath]

Interesting question. I haven't thought it through for the 2002 plan year yet, but for 2001, the elective deferrals reduce the earned income for purposes of the deduction calculations, and count against the 15% deduction limitation. So in your example, they can't "double up" for 2001. Again, I haven't worked through it for 2002. I agree with you that seems unlikely such a scenario is possible, but I have no basis yet for saying that other than a gut feeling.

[Guest pineapple]

Sorry to burst the bubble, but what about IRC 415 which limits annual additions to 25% of compensation for 2001 and 100% of compensation for 2002? Also IRC 404 which limits deductible contributions to 15% of eligible compensation for 2001 and 25% for 2002 (excluding 401k deferrals)? And that since the person is self-employed, you must offset his compensation by his contributions to calculate the deduction limit.

[mbozek]

P: if I understand u correctly then a Se person can contribute 11k to a 401(k) sal reduction plan and 20% of that amt ($2200) as an er in 2002 even if the employee earns 11k.

[Guest Bob Monte]

pineapple, your response and searching all over the place leads me to these conclusions for 2001.

Total contributions for the self employed would be limited to 20% with a max of 13.04% that could be the employer profit sharing and the remainder would be employee elective deferral.

It appears that the compensation actually has two definitions. Compensation for figuring the employer contribution is as defined in the pub 560 and the ER contribution is calculated as in that appendix. Elective deferrals are not considered at this point.

Although I cannot find any reference to it in any IRS pub, it seems that for figuring max employee deferral, compensation is now reduced by the amount of employer contribution.

So lets say that compensation after the reduction for 1/2 SE tax is 11,000 and then the max ER contribution is 13.04% of that $1434.40. Now to figure the allowable EE deferral subtract the 1434.4 from the 11,000 to give 9565.6. This would be the max EE deferral. But now the total cannot exceed 20% of 11,000 or $2200 and this value is the max from both sources. (a SIMPLE would be figured in simlar fashion)

Is this right? If so, which contribution must be decreased. Would the ER or EE amount be reduced? It seems that the ER portion would have preference since it is the first step and also because, if other emploees are involved, everyone should get the same ER %. On the other hand, EE deferalls are not subject to vesting and it seems unfair to limit it.

Am I getting closer or still way off base?

Another example with higher income:

Compensation (after 1/2SE tax) equals 30,000 limiting all additions to 6000. 30000 x .1304 = 3912 as employer profit sharing so employee elective deferral can only be 6000 - 3912 = 2088. Anyone agree/disagree?

Lastly, if a single person plan is in question, the ER % could be reduced to raise the EE deferral. To what benefit I don't know but just thinking. But all this means that this person with 30000 in compensation cannot contribute anywhere near the 11,500 contribution because of the overall 20% limit. RIGHT??