Compensation Questions

[Archimage]

I have a client that was the sole owner of an S-corporation. The S-corporation shutdown midyear and became an LLC. The plan continued. The client paid himself $168,000 from the S-corp and had a loss from the LLC. Would his year end compensation be $168,000 or 168,000 less the loss?

[Guest Moe Howard2]

Did the S-corp issue him a W-2 for the $168,000?

[GBurns]

Aren't K1 distributions also relevant?

[Gary Lesser]

Only the amount paid on Form W-2 would be treated as compensation in a plan of the Sub-S. Self-employment losses from an unrelated entity should not reduce W-2 compensation for QP or IRA contribution purposes (see later post). Dividend income, Sub-S or otherwise, may not be treated as plan compensation.

[R. Butler]

Is the LLC taxed as a sole propreitership? If so it seems to me that compensation will include both the W-2 income as an S-corp. employee and the earned income from the LLC.

[Archimage]

I did some more research on this subject. I found that the IRS was asked a question similar to this situation at the Joint Committee on Employee Benefits of the ABA back in 2001. The question basically stated that a participant received w-2 wages for the first half of the year and then became a partner and received a loss that was greater than his w-2 compensation. The IRS's position was that his compensation for the plan year was ZERO. The cite is

This is also mentioned in The ERISA Outline Book. Anyone have any other comments or opinions with this said?

[R. Butler]

Since that supports my response I'm going to go ahead and agree.

[Guest Moe Howard2]

Arch: I couldn't get to that cite (oh well I'll try latter).

In the meantime let me ask you about the example you cited.

Was there only one legal entity(employer). In other words, was he an employee of a partnership and then latter in the year he became a partner in that same partnership? If such is the case, then I can see how his eligible comp would be the net total of his W-2 salary plus his SE income (or loss) from the same employer.

[GBurns]

Gary Lesser,

Isn't this IRS position contrary to your post since the partnership loss would be a K-1 item, which you consider not includible?

[Archimage]

Moe, in my initial scenario the plan sponsor changed from an S-corporation to an LLC (taxed as partnership). He paid himself W-2 income while an S-corp. He was always the owner. I see your point, Moe, but I am still uncertain if that is the correct way to handle it.

I posed a question similar to this situation to the IRS Q&A session at the ASPA conference starting this weekend. I hope it gets a response. Hopefully I will run into Derrin Watson as well and maybe he can share his opinion.

[Guest Moe Howard2]

Arch: In my previous question to you, when I said "the example you cited" ... I was referring to the details of the question the IRS was asked in 2001 (which you cited) , not your initial scenario.

In that 2001 IRS question, was he a employee/participant in the partnerhip's plan ... and .... then later (within the same plan year) he became a partner/participant in that SAME partnerdhip's plan?

[Archimage]

Okay, sorry. Yes, this person was a regular employee and became a partner with the same firm mid-year.

[Guest Moe Howard2]

Arch: So, the facts/circumstances of the IRS position you cite are not the same as the example in your initial scenario question.

Namely, In your scenario the individual provided services to two separate entities (corp and partnership).. The IRS position you cited is in regards to the individual providing services to only one entiry (a partnership).

I'm leaning toward the belief that his partner loss cannot be netted against his corp salary (in your scenario) ...... but that his employee salary from partnership can be netted against his partner loss from the same partnership (in the IRS example you cited).

[GBurns]

Why would "shutdown midyear and became an LLC" signify 2 separate entities rather than just a change in corporate structure"? Even then although probably not on point but still analogous are such items as "successor" "same desk" etc.

Note the original post stated that "the plan continued".

[Guest Moe Howard2]

GBurns: A corp and a partnership are two separate entities for tax purposes. The corp can deduct retirement contributions that arise only from eligible compensation paid by the corp. A partner can deduct keogh contribution based only on his SE earnings from his partnership.

[GBurns]

For tax purposes BOTH an S Corp and an LLC (single member or partnership) are pass through entities. The "tax purposes" and treatment are the same. It takes place at the individual level.

[mbozek]

As noted by Gary, a contribution based on 168k of comp could be made by the S corp which would be deductible by the owner on his 1040 if the S corp makes a contribution before it dissolves. The loss from the LLC would be passed through the K-1 to the owner's 1040 as a deduction against the same class of income, e.g., capital gains or passive income. I dont think the 168k of S corp income can be counted by the owner to determine his deductible contribution for income on the LLC because they are separate employers for deductible contributions unless a consolidated return is filed for both entites which makes this an accounting question.

[GBurns]

But was it a dissolution or just a change in corporate form? Archimage in the second post used the term "changed".

This person was the sole shareholder in the S Corp and is the sole member in the LLC. Can an LLC partner/member be an employee of the LLC in this case? If the sole LLC partner/member cannot be an employee then how can the LLC be an employer of this person? Hence we could not have separate employer issue.

[Guest Moe Howard2]

mb: Yes, they (the corp & the partnership) are separate entities for their deductible contributions. Thus, they cannot net the compensation (or SE loss) of their employee/participant and partner/participant .... even though those participnats are the same person. And even though they use the same plan.

[Archimage]

This is strictly a hypothetical. When I posed the question, my thought pattern was that this is a change in corporate form.

[GBurns]

So you are saying that it was just a change in corporate form with acontinuation og the same plan.

Was the FEIN number of the entity for IRS reporting of 941 deposits and W2s etc changed?

[Gary Lesser]

While not dispositive of the issue, page 8 of Publication 590, regarding contributions to IRA, states:

Self-employment loss. If you have a net loss from self-employment, do not subtract the loss from your salaries or wages when figuring your total compensation.

I have always believed that "there is no such thing as negative compensation." However, when the businesses are not "separate and distict" some commentators have expressed concern that netting is required. If there were SE gains and losses from more than one unrelated entity, I do not think that netting is required, although the loss would have to be taken into account in computing the 1/2 of the SE tax deduction under Code Section 164(f) in computing the EI for the plan of the gain entity.

Where the plan is adopted by by both entities (as the facts may have suggested) or the entities "controlled/related/affiliated," netting (on second thought) may be required.

Little guidance exists on this issue. The plan probably is silent as to "losses" from SE, but probably does state that NESE is "compensation."

I have not found any PLRs on point.

[Archimage]

I tend to agree. If one has self-employment loss in a controlled group, then it needs to be netted. If it is two distinct businesses such, as in a case of an owner of two businesses that are not a controlled group but a multiple employer plan (or other similar scenario), then you would not net.