SE first half ... now incorporated... contribute $54K?

[K-t-F]

Client was SE as of 1/1/04 until recently and has made a $13,000 deferral to a Solo K for 2004. He has since closed a huge deal and his CPA told him to incorporate. He wants to establish a plan for the corporation. Can he make a $13,000 deferral to the SE plan from SE $, and in addition make a $41K contribution (no deferral) to the incorporated plan from the proceeds of this deal? This will mean he is going to shelter $54K for 2004 between the 2 plans... ok?

[alanm]

No he can't. The two should be aggregated for the 41k limit, which includes the deferral in the SE plan. A change in structure doesn't change that.

[K-t-F]

Because he is the owner of both businesses... thats what I thought. He will be limited to 41K total between the plans (deferrals included). Thanks

[david rigby]

Don't forget the deferral limit is individual, not related to employer(s), controlled group, etc.

[K-t-F]

Situation Update!!!

client has SE business "A". Also corporation "B". Wife works for totally unaffiliated company "C" in addition for company "B".

Client wants to max out company "B". He is going to make contribution to company "B" for himself and wife... $82,000 ($41K each...no deferral, corp contribution only). Wife will also defer $13,000 at company "C".

402g not violated... Ok?

[alanm]

ok, as long as she actually works for B and C and has the W2s

[K-t-F]

What about 1099?

[david rigby]

If she receives a 1099, is she really an employee? eligible to participate in the plan?

The $41K dollar limit is pretty good, but don't forget the 100% limitation.

[K-t-F]

True.. ok, 1099 is not the way to be paid.

What I have been told is it is a Sub S corp and (not being a CPA) if I understand it correctly, at the end of the year she, as a partner in the business, will receive her share of the profits which will be her compensation and in turn a contribution can be based. Her projected income will have to be $164k to receive the full deductible $41k (25%) contribution. Her $13K salary deferral will be paid through her other employer. The husband will not make a deferral (or his ER cont will be reduced by the $13k deferral keeping him under the $41k limit).

If this sounds right my question is how does she get paid... not a 1099 but what...

Thanks for the help!

[alanm]

Out of the sub S, she would get a K-1 with her distribution(pay) placed on the form line designated as earned income subject to SE tax. From corproation C she can get a W2 or 1099 with the amount of pay designated earned income subject to SE tax. As long as she pays Fica taxes on the pay, no matter what form is used, it can be used as a basis for a contribution.

[K-t-F]

Got it... thanks !!!

[Earl]

1120 K-1 does not have earned income. 1065 K-1 has earned income.

From Sub-S you can use W-2 only.

[alanm]

Not true. LIne 1 of the 1120s K-1 is for ordinary income from a trade or business. The instruction booklet says: if the income on line 1 is from active participation in the business, report the income on schedule E of the 1040. On schedule E is asks for designation if subject to self employment tax, and if so fill out Form SE. Turbo tax will do it all for you.

[Lame Duck]

I believe Earl is correct that only W-2 income may be used from an S-corporation. This may be from the IRS Audit Guidelines, but is definitely from the IRS

The courts have held that S-Corporation pass through income does not qualify as net earnings from self employment for Keogh plan deduction purposes because while section 401© extends the benefits of deductibility to sole proprietors and partners, it does not extend the benefits to S-Corporation shareholders.

The reasoning behind the IRS position seems to be that the plan is supported at the corporate level, not the individual level, so only income paid by the corporation is eligible for benefits. Dividends distributed on the K-1 are not compensation paid at the corporate level. The issue was discussed by the IRS in PLR8716060 and Rev. Rul. 59-221

[Earl]

I'm not a tax return preparer but I looked at the Schedule E instructions. The bold of the "not" at the bottom is bold in the instructions, I didn't add it.

Instructions for Schedule E (Form 1040)

If you are a shareholder in an S corporation, your share of the corporation’s aggregate losses and deductions (combined income, losses, and deductions) is limited to the ad-justed basis of your corporate stock and any

debt the corporation owes you. Any loss or deduction not allowed this year because of the basis limitation may be carried forward and deducted in a later year subject to the basis limitation for that year.

If you are claiming a deduction for your share of an aggregate loss, attach to your return a computation of the adjusted basis of your corporate stock and of any debt the corporation owes you. See the Schedule K-1 instructions for details.

After applying the basis limitation, the deductible amount of your aggregate losses and deductions may be further reduced by the at-risk rules and the passive activity loss rules. See page E-1.

Distributions of prior year accumulated earnings and profits of S corporations are dividends and are reported on Form 1040, line 9a.

Interest expense relating to the acquisition of shares in an S corporation may be fully deductible on Schedule E. For details, see Pub. 535.

Your share of the net income of an S corporation is not subject to self-employment tax.