Deductible pension plan contributions

[Gary]

Say a self-employed has net earned income of 150,000 (after 50% SE reduction).

Say he bases his contribution on earned income of 50,000 and the computed maximum deduction is 150,000.

Say he contributes 150,000.

Then 100,000 (150,000 - 50,000) is deducted on that year's 1040 and 50,000 is not deducted and is a carry over. Assume that he is not subject to excise tax.

We know carryover's can be applied to future year's as a deduction, but does anyone know if such carryover can be applied to a prior year's tax return, instead, to reduce a prior year's tax bill?

Thanks.

[SoCalActuary]

In a simpler world, you would determine the deductible contribution at $100,000. The next year's valuation would be performed, justifying at least $50,000 for the next year. Then the $150k deposit would be neatly divided between the two years.

Your method is more complex, since the IRS tries to force employers to specify the year for which the contribution is attributed. Now you must split a 2005 contribution into a part for which a deduction was taken and a part attributable to 2005 but deducted in 2006. This gets worse by the fact that you cannot claim the contribution was made after the completion of the tax year end or the date the tax return was filed. Nor can you claim it was made after the 5500 form was completed.

I would opt for the simpler world, but I hope to hear other interesting opinions on this.

[Guest greybeard]

I do not believe the ability to recapture previously paid taxes exists for an individual taxpayer, but I am no CPA. Is there any more specifics that you wish to share? Funding Method, Minimum Required Contribution, etc. I would attempt to find a set of reasonable assupmtions that would produce a $100,000 contribution with a plan comp of $50,000. For what it's worth.

[Gary]

In the case I describe, it is a first plan year and the client is wishing, hoping that the 50,000 excess could be used to reduce a prior year's taxable compensation. If it were a corporation then it would be easy. The entity could have a NOL of 50,000 and perhaps apply it to a prior year. It is a bit dicey on an individual tax return. The thought and hope for the client would be that they could reduce the prior year's 1040 business income by the 50,000, thus lowering the tax bill. Yes, I suppose the CPA's have to decide the feasibility of this. Of course if it were a corporation the 50,000 would be within the 404 limits.

But as a general question can a carryover be applied retrospectiviely, instead of prospectively? Especially for a tax year that is prior to the year the plan was put in existance?

[JAY21]

I know you're looking for facts, and not opinions, but I have to say I've never heard of such a thing with a Sole Prop and I've worked heavily with Sole Props for many years. It seems way to good to be true. I'd love to be wrong though, as I have many clients who would love this approach if someone knows of some support to do it.

[Belgarath]

I would say the answer is no. Under Revenue Ruling 81-114, it is established that a deduction cannot be allowed for a prior taxable year if the plan is not established by the end of that taxable year. I don't think it makes any diference if it is corporate or self employed.

I'm not a CPA either, so I'd recommend that you ask the client's CPA this question before the client makes any final decision.

[SoCalActuary]

After reading your question more carefully, I agree with Belg. The plan must be in existance in the fiscal year before the deduction is allowable. I would not support any retroactive deduction.

Further, you must determine the deductible amount in reference to the earned income of the participants.

If $50k of earned income produces $150k of contribution, fine, so long as you had $200k +SS taxes to work with. Instead you have $150k to work with, so you must adjust your earned income down and recompute your maximum deduction.

On the other hand, if you design the plan to provide $100k deduction on $50k earnings, then you have spent your allowable amount.

[Blinky the 3-eyed Fish]

I don't see the issue has any ambiguity. With a corp you could deduct the $150,000, create the NOL and possibly affect a prior year's return. With the sole prop you never get to deduct the $150,000 in the first place because the earned income is not high enough.

A carryover is an amount contributed but not deducted. It is completely different than a deduction that creates a NOL.

[Gary]

The responses are good.

I agree that we need to be careful with the issue that we are addressing.

So with that said, if the earned income (after SS tax deduction) is 150,000, then the total deduction pension plus pension earnings is of course limited to 150,000 and of course no NOL can be created for a sole prop.

Now we established the situation where a contribution in excess of earned income in the amount of 50,000 was made. And yes, this would be a carryover, and not deducted in that tax year.

The consensus is that we cannot apply this carryover in a prior year if it was before the plan was established. That sounds reasonable. What if this were the plan's second plan year and there was earned income from the prior year that was not fully deducted. Maybe (or maybe not) in this case a deduction could be retroactively taken in that prior year to offset some or all of the remaining earned income? Though, I too have never seen an explicit situation that allows for this.

Thanks for the help.

[Blinky the 3-eyed Fish]

The consensus is that we cannot apply this carryover in a prior year if it was before the plan was established. That sounds reasonable. What if this were the plan's second plan year and there was earned income from the prior year that was not fully deducted. Maybe (or maybe not) in this case a deduction could be retroactively taken in that prior year to offset some or all of the remaining earned income? Though, I too have never seen an explicit situation that allows for this.

Gary, I am confused. How could there be earned income in the prior year if you couldn't take the deduction in the first place because of the limited earned income? In other words, you were limited in the deduction to the NEI in year 1 in the first place. There isn't going to be a magical increase in the earned income in year 1 after the fact.

[Gary]

The consensus is that we cannot apply this carryover in a prior year if it was before the plan was established. That sounds reasonable. What if this were the plan's second plan year and there was earned income from the prior year that was not fully deducted. Maybe (or maybe not) in this case a deduction could be retroactively taken in that prior year to offset some or all of the remaining earned income? Though, I too have never seen an explicit situation that allows for this.

Gary, I am confused. How could there be earned income in the prior year if you couldn't take the deduction in the first place because of the limited earned income? In other words, you were limited in the deduction to the NEI in year 1 in the first place. There isn't going to be a magical increase in the earned income in year 1 after the fact.

The situation I referred to was for a plan that was in its first plan and the client apparently wanted to take a carryover from the first year and offset a prior year's earned income (when there was no plan).

[Blinky the 3-eyed Fish]

I think my point is being lost.

[SoCalActuary]

"The situation I referred to was for a plan that was in its first plan and the client apparently wanted to take a carryover from the first year and offset a prior year's earned income (when there was no plan)."

It might not be obvious, but I will try to make the point again. A prior year's income cannot be reduced for a sole-proprietor, when the plan did not exist in that prior year. If the sole proprietor had other expenses that should have been taken in the prior year, but were moved to a later year, that is a tax question. The pension is not one of those items.