What is partnership income for purposes of determining compensation for making an employer SIMPLE IRA contribution?

[jane123]

What is partnership income for purposes of determining compensation for making an employer SIMPLE IRA contribution? Is if the amount reported on the k-1 or must the k-1 amount be reduced by expenses deducted on the partner’s tax return in order to determine compensation.

[Gary Lesser]

For SIMPLE IRA purposes, compensation means net earnings from self employment (NESE) under Code Section 1402(a). One of the reductions in section 1402(a) requires a 7.65 percent reduction (for the 1/2 of SE tax deduction).

Line 15a of Schedule K-1 -- if properly completed -- is your starting point. Line 15a comes from a worksheet in the instructions that takes into account that certain items allocated at the partnership level (like gains/losses from sale of business property, unreimbursed partnership expenses, oil & gas depletion) that need to be reduced/added back in determining the amount on line 15a. E.g, gain from the sale of business property has to be deducted in arriving at the line 15a amount; the gain isn't "earned income." At this point the contributions for non owners have already been deducted at the partnership level (to regular partners) to arrive at the amount on line 15a.

Line 15(a) x .9235% = compensation for SIMPLE IRA plan purposes. Generally, this will be the same as the amount on line 4, Section A of Schedule SE (Form 1040). IMO, an owners total contribution (elective and maching/nonelective) can not exceed the .9235 amount. Contributions for nonowners can create a distributable loss.

Hope this helps.

[Lori Foresz]

Hi,

Just one comment. Doesn't line 15a * .9235 also need to be reduced for 1/2 of the SE Tax to arrive at Compensation for plan purposes? Then, you also have to decrease that number by the amount of er/matching contributions to actually get Earned Income??

Just curious.

[Gary Lesser]

Not in a SIMPLE IRA. The definition of compensation is different (based on IRC 1402(a) without regard to the SIMPLE IRA contributions). [iRC 408(p)(6)(A)]

That being said, the 7.65 percent reduction (the .9235 factor) comes from Code Section 1402(a)(12). That factor may also be used in computing the "1/2 of the SE tax deduction" applicable to a qualified plan or SEP, but not a SIMPLE IRA, under Code Section 401©(2)--called the "in-lieu of" deduction. In fact, it is always used because the SE tax has not yet been computed and 1/2 of it is needed.

In other words, the .9235 percent factor does the same thing as the earned income rule requiring 1/2 of the SE tax deduction to be subtracted to arrive at EI in a qualified plan or SEP, although it is directly applicable to a SIMPLE IRA.

Incidently, the "in-lieu of" factor may result in less SE tax being used in the reduction because the actual SE tax could be higher if TWB earnings are exceeded because of medicare (uncapped).

Hope this helps.

p.s. Welcome to our board.