Self-employed, earned income, pension deductions

[Gary]

Say a self employed has earned income of $600,000 (net of 50% SS taxes) carried over to the 1040. The person implemented a DB plan for that year as well.

My understanding is that the $600,000 is divided between income for pension purposes and the pension contribution (deduction).

Say 1st year val results are:

pension compensation of $200,000

max deductible contribution of $200,000

ERISA FFL of 800,000.

The individual decides to contribute 400k to pension where 200k is deductible.

Then my understanding is that 400k is taxable compensation.

Now for the 2nd year val results are as follows:

hypothetical scenario 1:

self-employed earned income is $150,000

say they choose 120,000 as pension comepensation and contribute 30,000, in cash where the minimum was 0 due to large CB and the max tax was say 160,000.

Clearly the 30k is deductible.

1. Is there any way they can deduct more than 30k (using 120k as pensin comp)?

i.e. deducting some of excess from prior year.

2. Or do they have to choose a lower pension comp (perhaps as low as $0) to deduct a larger amount (perhaps up to 150k) and have the available income?

Of course in this situation I believe the max deduction is 150k, based on $0 comp, even if the limit were higher than 150k.

Look forward to other views.

Thanks.

[flosfur]

First to point out the obvious: Are you aware that the $200k contributed in excess of the $200k deductible is subject to 10% excise tax - that's $20k in excise tax!

Now to the second year - the owner cannot decide what the pension compensation would be - it is decided by the amount deducted for the pension contribution which in turn depends on the computed contribution and earned income.

Since in your case you need to use up the $200k of excess contribution from the prior yr, you want to deduct as much as possible - which cannot be more than $150k. So you start with a pension comp of zero and compute the S404 plan contribution. If the contribution is $150 plus, you are OK. If the contribution is less than $150k, then you would use a pension comp of greater than zero and recompute the contribution. Repeat this process until Pension Comp + S404 contribution = $150k.

In the end you will still have $50k or more of undeductible contribution which is subject to 10% excise tax.

[Gary]

Contributions in excess of the deductible limit, but less than the ERISA FFL are not considered nondeductible contributions and are exempt from the 10% excise tax (IRC 4972©(7)).

Back to the original problem.

Say the 404 limit is 200k and they contribute 400k (which is below the ERISA FFL).

Then in the second year the plan sponsor creates a corp and the plan is amended to have the corp be the plan sponsor.

For the second year the corp has 150k of net income and uses 120 for comp.

The deductible limit is say 150k and minimum is 0.

The company contributes the remaining 30k of corp income, which is deductible.

Can the company deduct an additional 120k (i.e. up to the limit) from the prior year's 200k excess and create a corp loss for year of 150k, thus leaving a C/O of 50k?

Thanks.

[mbozek]

Your client needs to consult a tax advisor because there are several issues arising under the tax law, e.g., whether the corporation can use a loss incurred by another taxpayer. Also certain types of Corps are limited in the amount of deductions that can be used to generate tax losses- S corp deductions cannot exceed a shareholder's basis in the business.