Retroactive S Election by LLC - Owner Deferrals prior to Election

[austin3515]

As of January 1, 2003, taxpayer “Smith” is a member of an LLC – “Smith, Jones & Co.” The LLC is classified for federal income tax purposes as a partnership, and Mr. Smith as a partner. Mr. Smith’s “earnings” (made up of “draw” or “guaranteed payments” and his share of LLC profits) constitutes self-employment income.

On February 28, 2003, Smith, Jones & Co. files Form 8832 (Entity Classification Election), electing to be treated as an association taxable as a corporation, and on March 1, 2003, Smith, Jones & Co. files Form 2553 ( Election by a Small Business Corporation). Both of these elections are to be effective retroactively to January 1, 2003.

For calendar year 2003, Mr. Smith expects to make $120,000 ($10,000 per month), and wants to contribute $12,000 ($1,000 per month) to their 401-K plan. During January and February, Mr. Smith took a total “draw” of $24,000, and wrote his personal checks to the 401-K plan totaling $2,000.

Beginning March 1, 2003, Mr. Smith receives a salary of $10,000 per month, and has $1,000 per month withheld and paid into the 401-K plan. At December 31, 2003, Mr. Smith’s total wages are $100,000, and the total 401-K contribution on his W-2 Form is $10,000. Mr. Smith also receives a Schedule K-1 (Form 1120S) for 2003, showing the $20,000 of “draw” for January and February, as well as any additional profits for the year. None of these K-1 profits are self-employment income, since Smith, Jones & Co. is retroactively treated as an S corporation for the entire year.

How can Mr. Smith qualify the $2,000 paid into the 401-K plan during January and February for deductible 401-K contribution treatment? Is there any support for “grossing-up” his Form W-2 to include either the $20,000 paid to him during January and February, or the $2,000 paid into the 401-K period out of this January/February income? Does Mr. Smith need to withdraw this $2,000 (plus earnings), and recontribute it out of March – December wages, in order to perfect the 2003 contribution deduction/deferral?