S-corp. pass thru income & dividends

[R. Butler]

Nothing has changed concerning S-Corp. profits & dividends not being treated as plan comp. has it? I have been hammered by several different people this week disagreeging with me on that issue. So much so that I am wondering if I missed something & all of the sudden they count as comp..

[rcline46]

Nothing has changed. Don't you love people who know your job better than you?

Have them quote to you the IRC code that permits usage. Of course your answer is the document only uses stuff under 3401 (or W-2). It ain't there!

[Belgarath]

I also refer them to the Durando case, and PLR 8716060. R.Butler - I can sympathize - I also am constantly fighting on this one. We've had to go as far as terminating services on a couple of plans where they simply won't listen.

[R. Butler]

Thanks for the cites I knew the Durando case. I couldn't find it on the web; I'll probably have to go to the U.K. law library & copy it. I'll look for that PLR also.

I'll tell you I'm running into this argument from other CPAs. Some are adament that this changed with EGTRRA. (Of course they have no basis for that position.) What was more disconcerting, however, is that supposedly a major investment firm with in-house administration has ran an illustration for a prospective client including that pass through income. We may not get that client because the other proposal comes up with better numbers. I tell the prospective client that the better numbers are based on erroneous figures, but really when their CPA also disagrees; it does become difficult.

Thanks again for the responses & actually as I was typing this a friend was able to fax me a copy of that Durando case. At least I have a little ammunition now.

[Belgarath]

Here's the text of the PLR - it's fairly short and to the point as these things go.

Letter Ruling 8716060

January 21, 1987

Uniform Issue List No. 0401.10-00

Uniform Issue List Information:

0401.10-00

Qualified pension, profit-sharing, and stock bonus plan

Self-employed plans--definitions

UIL No. 401.10-00 Qualified pension, profit-sharing, and stock bonus plan, Self-employed plans--definitions

This is in response to a March 6, 1986, request for a private letter ruling, submitted on your behalf by your authorized representative, concerning your eligibility to establish self-

employment retirement plans under section 401(a) of the Internal Revenue Code based upon earnings derived from Corporation M.

The following facts and representations have been submitted on your behalf:

You own Corporation M, an ‘S corporation‘ within the meaning of section 1361(a)(1) of the Code. Corporation M is a commodities dealer actively engaged in the trade or business

of buying and selling regulated futures contracts within the meaning of section 1256(b)(1) and (g)(1) of the Code, and is registered with the Board of Trade of Kansas City, Missouri,

Inc., a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission.

Corporation M has no employees and does not currently maintain any pension plans qualified under section 401(a) of the Code. As a representative of M you execute all trades of

futures contracts on a full-time basis, and the income derived from these trades constitutes your livelihood and support. You propose to adopt a self-employed retirement plan and

trust qualified under section 401(a) and meeting the requirements of section 401© and (d) and to make contributions thereto based upon income earned as a shareholder of

Corporation M.

Based on the foregoing, you have requested the following rulings:

(1) That income you derive from trades of future contracts made by Corporation M constitutes earnings from self-employment to you for purposes of applying the tax on

self-employment income;

(2) That you, as shareholder of Corporation M may adopt and maintain pension plans, qualified under section 401(a) and satisfying the requirements of sections 401© and (d) of

the Code, based upon said income derived from gains and losses on contracts under section 1256 of the Code and which is passed through Corporation M to you; and,

(3) That you are engaged in a trade or business which would entitle you to make contributions to a plan qualified under section 401(a) as an owner-employee with respect to said

earned income under section 401(d)(3).

Concerning ruling request 1, section 1402(a) of the Code, in general, defines ‘net earnings from self-employment‘ as the gross income derived by an individual from any trade or

business carried on by such individual, less the allowable deductions attributable to such trade or business, plus the individual’s distributive share (whether or not distributed) of

income or loss from any trade or business carried on by a partnership of which the individual is a member.

Section 1402(b) of the Code, in general, defines ‘self-employment income‘ as the net earnings from self-employment derived by an individual during any taxable year which is $400

or more and not in excess of the applicable contribution and benefit base.

Section 1402© of the Code, in general, provides that the term ‘trade or business‘, when used with reference to self-employment income or net earnings from self-employment, shall

have the same meaning as when used in section 162 (relating to trade or business expenses).

Revenue Ruling 59-221, 1959-1 C.B. 225, concerns the undistributed taxable income required to be included in the gross income of shareholders of an S corporation. The ruling

explains that amounts which must be taken into account in computing an S corporation’s shareholder’s income tax are not derived from a trade or business carried on by such

shareholder. Neither the election by a corporation as to the manner in which it will be taxed for federal income tax purposes nor the consent thereto by the persons who are

shareholders results in the consenting shareholder’s being engaged in carrying on the corporations’ trade or business. Therefore, these amounts are not included in computing net

earnings from self- employment for self-employment tax purposes.

Based on Rev. Rul. 59-221, the income you derive from trades of futures contracts made by Corporation M is not considered self- employment income. Neither the election by

Corporation M to be treated as an S corporation nor your consent to the election results in your carrying on Corporation M’s trade or business. Consequently, with respect to ruling

request 1, we conclude that the amounts received by you from Corporation M are not included in computing net earnings from self-employment for self-employment tax purposes.

Concerning ruling request 2, section 401©(1)(B) of the Code provides that a self-employed individual means with respect to any taxable year, an individual who has earned income

(as defined in paragraph 401©(2) for such taxable year. Earned income under paragraph (2) means net earnings from self-employment (as defined in section 1402(a) of the Code).

Inasmuch as we have concluded in ruling request one that amounts you received from Corporation M are not net earnings from self- employment under section 1402(a), we

conclude with respect to ruling request 2, that you are not eligible to adopt and maintain pension plans qualified under section 401(a) and satisfying the requirements of sections

401© and (d) of the Code based upon income derived from Corporation M since it does not constitute earned income as defined under section 401©(2) of the Code.

With respect to ruling request 3, we conclude, based upon our findings in requests 1 and 2, that the issue presented is moot.

A copy this ruling is being sent to your authorized representative in accordance with a power of attorney on file in this office.

Allen Katz

Chief, Employee Plans

Rulings Branch

[R. Butler]

Thanks, that is very helpful.