Sole Proprietorship Valuation

[Blinky the 3-eyed Fish]

A sole proprietorship has a DB plan with a beginning of the year valuation date. My question relates to what estimated compensation to assume for the current plan year. The salary scale is 0%.

Traditionally, I have assumed the same earned income as in the prior year (line 31 of the Schedule C) and reduced it for 1/2 of the SE taxes and the current year deduction, the old circular calculation of fun.

I have a plan I am new to this year in which the compensation assumed was last year's net earned income (last year's earned income reduced by last year's SE taxes and deduction). In other words, it is like a plan sponsored by a corporation, where the W-2 compensation is assumed to be the same as the prior year.

Do you think this is an acceptable assumption?

[mwyatt]

Blinky:

Not quite sure what you are asking here. Do you mean in the second example that the 2001 valuation (performed as of 1/1/2001) was done using assets as of 1/1/2001, but used the 2001 net earned income (analogous to a BOY val using comp paid during the year of the val - think we had a message board discussion about that not too long ago). Your first situation as of 1/1/2001 was performed using 2000 NEI (Net Sch C less SET deduction less Contribution). Please clarify...

[Blinky the 3-eyed Fish]

Let me try a numerical example.

Valuation date: 1/1/02

2001 Earned Income (line 31 2001 Sch C): 100,000

1/2 SE Taxes: 6,324

2001 Deduction: 50,000

2001 Net Earned Income (i.e. Compensation): 43,676

Normally in this situation I would assume that the 2002 Compensation (with a 0% salary scale) is as follows:

2002 Earned Income (assumed same as 2001 EI): 100,000

1/2 SE Taxes (based on 2002 twb): 6,603

2002 Deduction: X (let's call it 45,000 so the numerical example can continue)

2002 Net Earned Income (i.e. Compensation): 48,397

Plan that am new to assumed the prior year's compensation (i.e 43,676) was the 2002 compensation.

I am asking people's opinions as to whether this is acceptable.

[mwyatt]

I for one usually just use prior year's NEI when doing beginning of year valuations. I can see your logic of projecting prior year's NEI, and then adjusting for current year SET and possibly current year contribution, but in the end don't you just end up with an artificial figure anyway since you're not using current year Sch C Income? I would just use the prior year's NEI, since this is analogous to the corporate side, and given your logic, which I'm not disputing, wouldn't you again make these adjustments as well for the corporate side for principals since there is a total amount expended by the Employer (salary, Employer FICA, and contribution) in determining salary for current year?

[Guest dsyrett]

I always use prior year's NEI although I think your way would be acceptable.

[Mike Preston]

With a BOY valuation, the compensation to use in the year is always a projection. Seems like the question is whether or not the projection is a reasonable one. While I dislike your methond (too complicated and gets to be way, way too complicated if employees involved), I see nothing that makes it unreasonable.

[Blinky the 3-eyed Fish]

Okay, thanks to all. As far as the complexity, I haven't noticed it being a problem. To me the complexity would be no different than if I was running and end-of-the-year valuation.