Partnership Plan and Plan Deduction Logistics

[Gary]

Say there is a plan for 6 partners/doctors and their employees.

Presumably the partnership makes the defined contribution plan contributions (as a company expense) along with other expenses to arrive at net income for the partnership and such net income is allocated on a Schedule K-1 for each partner.

In looking at a client's (one of the partners) 1040 return, it has generated some questions.

One expectation is that the pension contributions are deductible to the entire partnership and not shown or don't appear on the individual return.

However, this client/partner showed $110,000 of income from the K-1 passed to the 1040 and a qualified contribution of $41,000 for 2004.

The impression is that the $41,000 does not exceed 100% of the partner's compensation and in the aggregate, based on the entire plan, the $41,000 plus all other contributions did not exceed the aggregate limit of 25%.

Question is: Is this a correct way of handling this from a tax return perspective or should no contribution show up on the 1040?

Thanks

[Guest Ron Sevcik]

The Form 1065 (partnership return) only shows the deduction for the common law employees. Therefore, the income shown on the K-1 is before the contribution for the partner. The partner takes his deduction on his 1040 as your client did.

However, I find it hard to believe that he can get a $41,000 contribution on a salary of $69,000 (total income of $110,000 minus contribution of $41,000). And actually, it is less than $69,000 because FICA also comes off of the $110,000 before the contribution.

[SoCalActuary]

If this was a DB plan (which this forum covers), then the $41,000 would be possible with no problem.

If this is a DC plan, then one participant gets more than 25% of pay contribution. This may be ok if the plan has cross-testing and there are enough other participants getting less than 25% of pay.

[Gary]

I don't administer the DC plan, but yes I agree, the aggregate contribution for that plan cannot exceed 25%, though for one person it can be as much as 100%.

Thanks.

[Guest Ron Sevcik]

Gary, in your initial post, I disagree with the following 2 statements which you made:

"Presumably the partnership makes the defined contribution plan contributions (as a company expense) along with other expenses to arrive at net income for the partnership and such net income is allocated on a Schedule K-1 for each partner."

"One expectation is that the pension contributions are deductible to the entire partnership and not shown or don't appear on the individual return."

On Form 1065, line 18 is where the deduction for retirement plans is taken. In the instructions for the 1065, line 18, the very first paragraph reads as follows:

Do not deduct payments for partners to retirement or deferred compensation plans including IRAs, qualified plans, and simplified employee pension (SEP) and SIMPLE IRA plans on this line. These amounts are reported on Schedule K-1, line 11, and are deducted by the partners on their own returns.

It goes on the say that only contributions to common-law employees should be shown on line 18. Therefore, I believe your client did his return correctly.

[mbozek]

The Pship deducts the contributions for both employees and partners on its return without regard to what can be deducted by each partner. The Pship contributions for the Partners are reported on each partner's K-1 along with the partners net earnings from Self employment from the pship without reduction for pship contribution to the 401k plan. The net earnings from SE appear as taxable income on the partners 1040 and the pship contribution is deducted on line 32 of the 1040 to the extent permitted under IRC 404. A self employed person's deduction is limited to 20% of net earnings from SE (less 1/2 of FICA tax paid). I believe that salary reduction contributions to the 401k plan are not counted for the 20% limit.

If the partner's net earning from the pship are $110,000 the max deduction for a DC plan will be:

$110,000 -$7185 (1/2 FICA tax) = $102,815 x .20= 20,563+14,000 (401k)= $34,563.

See IRS Pub 560, P 14.

If the $41,000 contribution is for the partner's accrued benefit under a DB plan then the amount of the contribution in excess of 20% of net earnings is deductible to the extent necessary to meet the minimum funding standard under IRC 412.

[Guest Ron Sevcik]

Mbozek, I don't understand the first sentence in your reply. Are you saying that the entire contribution is deducted on line 18 of the 1065 and, therefore, you don't agree with the instructions for line 18?

[mbozek]

I dont understand your question. The Pship deducts contributions to CL employees pensions on line 18 as a reduction of Pship taxable income. The Pship reduces its taxable income by the amount of Net Earnings from SE (including pension contributions) allocated to each partner as income from the pship. Either way the contributions for pension contributions are allocated to the partners as either NE from SE (partners contributions) or a reduction of NE from SE (pship contributions for CL employees). Each partner deducts the amount of the Pship contribution to their pension benefits from taxable income on their 1040.

[Guest Ron Sevcik]

Okay, I think we are both saying the same thing. I am just saying that the partnership does not take a separate deduction for the partners contributions. It takes a deduction for the partners net income which includes the contribution which, I believe, is exactly what you are saying in different words.