Deductibility of contributions for S-Corp

[Guest TracyAndrews]

We are having a situation (or should I say difference of opinion) with certain CPA's with whom we work to determine pension contribution for our clients. We have for instance a Profit Sharing Plan with a $25,500 contribution that would be required to maximize the sole owner of a S-Corp. We provide this figure to the client in February as our recommendation for the current year. He funds the Plan by March 15. Now the CPA takes a deduction for $25,500 on the S-Corp return forcing the client to a net loss for the year, since there weren't sufficient profits to support a $25,500 deduction. I was under the impression you could not deduct in excess of the S-Corporation Profit. Is this true? I can't get any CPA to commit to an answer one way or the other. Now the CPA is unhappy because he believes we should be asking for the estimated S-Corp profit BEFORE determining any pension contributions. We believe that his job to decide what to deduct/not deduct, not ours. Has ANYONE come across this issue. Do you ask for S-Corp income before providing a contribution report for your clients?

[Archimage]

I do not know of a requirement that says you cannot deduct a contribution that would put you in the red. The contribution is treated as a business expense similar to other business expenses. The client will be able to carry the loss back and/or forward to prior years in order to reduce tax liability. However, I am under the assumption that this contribution is for the sole partner/shareholder. Tax treatment for S corps are very similar to partnerships. If a contribution is made to a partner in a partnership, the deduction would be included on the individual's K-1 of Form 1065 and then included on his 1040 as a deduction from his gross income. This may be the case for your S corp problem. Unfortunately, I am a CPA that does not practice in taxation of businesses but hopefully this will get you started.

[Belgarath]

Archimage's response seems reasonable to me, but I freely admit I don't know the answer. In response to your other question: no, I've never had a CPA ask this, and no, we do not ask it up front either. For a profit sharing plan, unless they tell us up front what contribution they want, we just calculate maximum (or most favorable maximum if cross-tested, etc.), based upon the W-2 income, then let them confirm what level of contribution they want.

[Guest TracyAndrews]

Thank you for the replies thus far, but does anyone have an idea where I can find out the answer? I can't believe what a can of worms this has opened (here anyway)...Any suggestions would be greatly appreciated, we've been looking at all your normal resources but to no avail. :confused:

[Archimage]

I just read my post and I think I left out one point. The deduction for the partnership would NOT be included on the partnership return but on the K1 for the individual partner. S corps have characteristics like C corporations but are taxed similar to partnerships. But I do not know sure how that deduction is handled for S corps.

[Mike Preston]

We ask for S-Corp income in those situations where we would ask for C-corp income. There is no difference from a plan perspective.

There is no question that a contribution to the plan is deductible by the S-Corp if would be deductible by a C-corp. If it throws the S-corp into the red, so be it. The pass through of the loss is precisely why the entity put itself on the map as an S-corp to begin with.

Whether the pass-through to the shareholders is deductible or not on their individual tax returns depends, in part, on the basis of the entity as of the end of the tax year. Again, this is standard S-corp stuff that every CPA should know. Heck, I know it and I'm not a CPA.

But, just to careful here, since I'm not a CPA you should check with a CPA who actually knows the rules in your state, because state issues might be different from federal.

Unless there has been a change in the law since I last reviewed this stuff. Again, check with a CPA who says they know the rules with respect to S-Corps.

[Guest TracyAndrews]

I will add something to the equation now. This shareholder actually personally LOANED 25,500 into the corporation in order to make this deduction. (We found this out after the fact of course). This seems like tax evasion rather than proper tax planning. Your thoughts?

[Mike Preston]

Why does a loan to the corporation by a shareholder (an event that happens routinely) to enable the corporation to meet its obligations (a contribution to its qualified plan) strike you as anything other than an every day occurrence?

[Guest TracyAndrews]

Back to the same point, the contribution was not generated by earned income by the corporation. If the owner takes a salary (on which to base the contribution) that forces the corporation into a loss, then there would be no earned income to generate a contribution.

[Belgarath]

This is starting to get confusing. Did the owner receive W-2 income or not? If so, then a contribution can be made (or must be made if a pension plan as opposed to a profit sharing plan) to the profit sharing plan.

Whether all or only a portion of the contribution is currently deductible is a separate question, which their CPA should be able to answer after doing some research. As I said before, I don't know the answer, but Archimage's answer seems right to me.

[Mike Preston]

I agree with Belgarath. This is the first mention of the possibility that the compensation under the terms of the plan is in question. My comment was limited to the contribution. However, with that said, there is no difference if the loan is used to satisfy pension obligations or is turned around and paid out as W-2 (so as to increase the required pension contribution). There are, of course, ramifications of increasing W-2 (payroll taxes), but there is nothing I'm aware of that restricts a loan for this purpose either. I suppose one could get really esoteric and start discussing reasonable compensation issues. But usually those issues revolve around under-utilization of W-2 income.

[Guest TracyAndrews]

Thanks for your thoughts...you are right this is getting confusing. We always provide the optimum contribution alternatives to our clients when presented with their W-2's in Jan or Feb, but we have never asked for a draft of their 1120-S Form to see if there were profits. It isn't so much the loan that worried me, but the fact he was deducting against no profits.

[Archimage]

The key thing to remember here is that this is a corporation. This is just one of the business expenses that are charged against earnings. Many corporations contribute to plans that have losses for a given year. Sometimes shareholders do loan money to the corporation to meet certain obligations. I think this is what is happening here in your case.

[BeckyMiller]

O.k. Tax accountant entering the fray.

1. The general discussion is pretty accurate to date.

This is a corporation, the deduction is calculated just like a regular corporation.

2. The shareholder has to have W-2 wages to be a basis for the contribution. It is not calculated based upon his or her pass-through income. So, the fact that this puts the corporation into a loss position does not eliminate the right to make the contribution.

3. Even if it is a profit sharing plan that requires that the contribution be paid out of current profits, you may be o.k. There were sufficient current profits before the contribution. (Now, if you went into a loss situation, there might be a partial problem here.) Since 1986 few profit sharing plans have retained this requirement, however, so that particular limitation would surprise me.

4. It is very common for S corporation shareholders to make personal loans to corporations. The ability to deduct the S corporation losses on their personal returns is limited by a variety of rules. One is the "passive loss" rules. Another is that they cannot take a deduction in excess of their basis in the stock. Certain types of loans create basis.

[Guest TracyAndrews]

Thanks for the reply. I know this conversation has gotten somewhat convoluted at times, however we did find a reference in the new ERISA Outline book regarding one person S-corps that speaks of "zeroing out" between compensation and contribution, and not forcing into a negative situation.