Who takes deduction for controlled group contribution

[Guest jgordon]

HELP! Client is a controlled group and does not file a consolidated return. One company is a management company and employs the two owners (the owners' W-2 compensation is paid by management company). Other company is the "productive" company employing all other employees (about 100 employees). The productive company has been making the contribution to the cross tested profit sharing plan and taking the deduction for the contribution. Obviously $80,000 of that contribution is deducted on the productive company's return, but the corresponding $400,000 of compensation is not on that return. Therefore, an agent could possibly look at the return and decide that the contribution is greater than the 25% of compensation deduction permitted because there would be no notice of the controlled group on the 1120S. Something about this does not seem right to me. It seems as if the IRS would have a problem with the productive corp (who has greater income) taking the full deduction on its return. However, I can not find any authority one way or the other (I want something to back up my conclusion when I decide to make an issue of this). Does anyone have any idea if this method of contributing to a plan and taking a full deduction is ok or wrong? Thanks.

[Blinky the 3-eyed Fish]

I don't believe there is set guidance for a situation like this. If the deduction is more than 25% of compensation for the productive company, it is not definitively wrong, as far as I know, since the employers are one company for 404 purposes. So long as the deduction is less than 25% of overall compensation, you should be okay.

But like I said, there is not clear guidance. The conservative approach would be to limit the deduction in any one company to 25% of that company's eligible compensation.

The ultimate conservative approach would be to deduct only allocations to the respective employees of that company.

[Guest jgordon]

Just in case anyone is curious, I think I found an answer to my own question. The answer lies in IRC Section 162 and a litnany of case under 162. The productive corp may not take the deduction for the contribution may on behalf of the non- productive corp's employees (however there is a very narrow exclusion). See Columbian Rope v. Commisioner 42 T.C. 800.

Thanks for your response Blinky.

[Ron Snyder]

Your "answer" is not correct because section 162 applies to deductions claimed as ordinary and necessary business expenses. Section 404 authorizes tax deductions for contributions to retirement plans.

Under that section, employers are allowed tax deductions for contributions to qualified plans within the limitations provided therein.

The exclusive benefit rule of IRC 401(a)(2) generally precludes contributions by one employer from going to the employees of another employer. However, when 2 employers are aggregated for tax purposes this requirement is waived.

In the case you describe, the employers are NOT aggregated for tax purposes, but would be for testing purposes under IRC 414(b) or ©. Under such circumstances, in order to make sure that you are doing it correctly:

1. Each employer which elects to participate in the plan should separately adopt.

2. Each employer should contrirbute for its own employees and claim its own tax deductions.

3. All employers of the group should be aggregated for testing purposes.

[Guest jgordon]

Actually, 404 does not authorize deductions for contributions to retirement plans. Specifically, 404 states that "if contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity pla, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under this chapter; but if they would otherwise be deductible, they shall be deductible under this section, subject, however, to the following limitations. . ."

Section 162(a) provides for a deduction for "reasonable allowance for salaries or other compensation for personal services actually rendered".

In order to take a deduction everything must first come under 162 or 212. Please refer to the case I previously cited.

[GBurns]

Deductions are not usually, if ever at all, deductible 404 they are 162 as posted by jgordon.