Maybe it's because my brain is fried from October 15th, but I can't get my head around this off calendar plan question.

[Guest smhjr]

Client has a contract that will soon begin paying her $20,000 per month. She was a W-2 employee for 10 months of the 2004 calendar year. Her new endeavor is an LLC in which the contract will be paying her. The LLC will have a year end of 12/31.

She would like to put in a profit sharing plan and deposit $41,000 between 11/1 and 12/31 taking the deduction on her 2004 return. Her plan year would be 11/1/04 through 10/31/05. Her salary during the plan year will be $240,000.

On one hand I look at this and say how can an LLC (taxed as self employed) put in a contribution that is higher than she will even make in her LLC during the 2004 calendar year?

On the other hand it seems like it is ok to fund her profit sharing contribution during the plan's fiscal year and take the deduction on her applicable tax return. The loss generated would offset some of her taxes owed while she was a W-2 employee.

Obviously if this were an LLC that only made $40,000 in income during a calendar year with a calendar plan there is no way she could deduct a $41,000 plan contribution. Also if we had a short plan year the first year she also would not be able to deduct $41,000.

I feel like I know this or should know this but somehow have confused myself and I can't straighten myself out. Maybe I just need to sleep a lot this weekend and think about it Monday.

Can someone straighten me out?

[Ron Snyder]

So you're client wants to take a $41,000 tax deduction on $40,000 of compensation? What about the 25% limit under IRC 404(a)?

[GBurns]

Is she a member/partner of the LLC?

Are you saying that she was a W2 employee of some other company for 10 months and now for the last 2 months of the calendar year she will not be a W2 employee of that same company? What will she be? Is there arelationship between the 2 entities? Why does she think that a contract changes her from a W2 employee to something else?

LLC taxes as self-employed? That indicates that she is the sole shareholder, which makes the thought process even stranger. Is she trying to give herself a contract or is this a contract between the LLC and a client that will be bringing in $20,000 per month in revenue? If it is, then you do not yet know how much will be profit etc, do you?

[Guest smhjr]

vebaguru,

Yes her tax year and plan year will be different. The plan uses plan year compensation from 11/1-10/31 to calculate her benefit, but her tax year ends in December and to date her contract will have only paid $40,000 by December. THe question is if she deposits the contribution in 2004 wouldn't she have to deduct it on her 2004 tax return? It doesn't seem right to deduct it on a 2005 return.

GBurns,

She was an employee of an unrelated company for 10 months of the year. She has now been awarded a contract to perform a service and that will begin on November 1. She has quit her job as a W-2 employee and is starting the LLC with it's initial income being this contract. Yes she is the sole member/partner of the LLC. There are no other people employed by the LLC.

I don't know all of the details of her past W-2 work or exactly what her new endeavor is, but it has something to do with the entertainment industry. I think she is doing something behind the scenes for a television show. The contract is for one year, and I have been told that the LLC's expenses will be relatively low because it is her expertise that she is being paid for. They are confident there is no way for her to run into 25% deductibility issues.

The reason I mentioned the prior W-2 employment is that the loss created by the $41,000 contribution that will pass through to her individual tax return could offset other tax liabilities. That is of course I can convince myself that this is ok.

[GBurns]

I think I see some of what I find confusing.

She wants to set up a PS for the LLC in 2004 and contribute $40,000 which will be earned from the LLC. If this is so then the W2 income is irrelevant. She could not make a contribution to any PS plan using the W2 income, anyhow since she was an employee whose employer had no PS nor did she make an election etc.

I am also trying to figure out how you arrived at there being a "loss created by the $41,000 contribution that will pass through to her individual tax return could offset other tax liabilities". The "loss" and "offset" are what I do not understand even with this $41,000 being from the LLC under the LLC's PS plan.

I wonder what others see and understand?

[mbozek]

Assuming the client is a calendar yr taxpayer, she will have 40k of income for 04 attributable to the LLC and can take a deduction on her 1040 for 20% of her net earnings from self employment after reduction for 1/2 of the Fica tax if a qual plan is established by 12/31/04. See Rev Rul 76-28 and IRS pub 560. Otherwise she can take the same deduction to a SEP plan established for the LLC by the date for filing the 04 tax return with extensions. IRS Pub 560. She should have a plan yr and a tax year that both end on 12/31 since comp earned in a plan yr that ends after the employer's taxable year is not deductible for that tax year. Rev Rul 90-105.

[Guest smhjr]

mbozek,

90-105 was very helpful. According to the ruling, from an income tax perspective the income is earned in a future tax year and therefore the contribution on that income can not be currently deductible. Of course then the last paragraph says that this revenue ruling does not address similar issues that may arise under section 404 with respect to plans that are not subject to section 401(k) or 401(m). All of the discussion was in regards to deferrals and matching contributions.

Contained in the ruling there is a paragraph that reads: "Section 404(a) provides in relevant part that if contributions are paid to a profit sharing or stock bonus plan and are otherwise deductible under Chapter 1 of the Code, those contributions are deductible under 404 (subject to certain limitations) in the taxable year of the employer when paid, and are not deductible under any other section of chapter 1 of the code." It does go on to say, "...the contribtuion must be an ordinary and necessary expense for the production of income and must be compensation for services actually rendered."

You mentioned that the indivdual should have a plan and tax year that are the same, but I think we would agree that it is not required. What if the facts of the case changed and she earned $100,000 in the last two months of 2004 and then $140,000 in 2005. $100,000 of that income would be attributable to a previous tax year and common sense (from reading 90-105) would lead me to believe that you can not deduct a contribution for income from a previous year either. Right?

The advisor (who is a good referral source for us and my boss is basically telling me to find a way) wants me to figure out how to maximize the 2004 tax deduction. After explaining him the above, he now wants to know if my answer changes if they adopt a 25% money purchase plan or a beginning of year valued defined benefit plan in order to use required minimum funding to her advantage.

I really am not trying to be argumentative just for arguments sake. I'm all for a short plan year and then a full year for 2005 that would make my life a lot easier, but in this case I need to explore everything.

[mbozek]

If she is self employed her max deducton to a DC plan would be 41k (20% of $205k max comp limit) if comp is paid in 2004. If she is over 50 she could contribute an additional 3k to a 401k plan. Don't know why you want a mp plan when a PS/401k plan provides the same deduction. Deduction for DB plan depends on minimum funding requirement and various limits to benefit accrual, e.g. max retirement benefit limit of 165K is phased in over 10 years. You need to consult with an actuary to determine max deduction to DB plan for 2004.

I dont understand your reference to 100k attributable in previous year year. If she earns 100k from SE in last 2 months of 2004 and 140k in 05 she can deduct 20k (ignoring the FICA reduction) on her 2004 tax return and 28k (20% of 140k) on her 2005 tax return since SE persons are calander year taxpayers. See rev rul 76-28.