self employed and max 401(k)/ps deduction

[Guest ctrapatsos]

hello...

if a self employed over 60 years old has schedule c item 31 income for 2006 of 23K, is the max he can put into a 401(k) profit sharing for 2006 calculated as

$15K deferral

$5K catchup

$3k profit sharing (limited so that total is 100% of item 31)

------

for a total of $23K deposit

or is it

$15K deferral

$3K profit sharing

$2K catchup

---------

for a total of $20K deposit

because i would need to take the ($23k minus $3K ps) to get the 100% of pay number?

thanks for your help

chris

[Blinky the 3-eyed Fish]

Neither.

First, you must reduce the net earned income by one-half of self-employment taxes.

23,000 * .9235 * .0765 = 1,625

23,000 - 1,625 = 21,375

Allowable deduction of ER contribution is 25% of earned income. Earned income is reduced by the ER contribution.

Therefore - 21,375 *.2 = 4,275 = allowable employer contribution

Check - (21,375 - 4,275) * .25 = 4,275

Catchup contributions don't count against the 415 limit, so total allocation are

$15,000 - 401(k) deferrals

$5,000 - catchup deferrals

$4,275 - employer contribution

$24,275 - total

[Guest mjb]

For a Self employed person how is the $1275 in excess of the Sked C income contributed to the plan?

[Guest mjb]

I dont understand your answer. Contributions can only be made by the employee or employer. If net income from self employment is only 23k how can 24,275 be contributed to the plan? Are you saying that the self employed person would make a contribution with non employment income? Under 172(d)(4)(D) the amount of the deduction for a self employed person's contributions to a retirement plan cannot be used to create or increase a net operating loss. I dont agreee with your comment that the $20,000 sal reduction contributions dont factor into the deduction limit- under 404(n) they are not counted for the purpose of the 25% deduction limit on employer contributions under IRC 404(a)(3) but are still deductible by the employer which when added to the employer contribution of $4275 would result in a deduction in excess of net income which results in an operating loss under 172(d)(4)(D).

[Bird]

I don't think deferrals can exceed earned income, even if catchups are available. A W-2 employee can't contribute more than 100% of pay, and I don't believe a Sch C taxpayer can either. (Although total contributions can exceed 100% of pay.)

Here we have 21,375-4,275 PS = 17,100 net earned income after PS contribution.

So the max (total) deferral is 17,100. Applying 415 (100% of pay) to the deferral contribution, before catchups, we're left with 12,825 (17,100-4,275). But we haven't used up all of the earned income, and catchups allow us to do that, to the tune of 4,275 (17,100-12,825).

$12,825 - 401(k) deferrals

$4,275 - catchup deferrals

$4,275 - employer contribution

$21,375 - total

In this case 415 is the limit that defines the catchups, not 402(g).

[WDIK]

I thought that according to Code Section 414(v)(3)(A)(i) that catch-up contributions were not subject to the limitations under 415(c ).

[Blinky the 3-eyed Fish]

Bird, good point about not being able to defer more than 100% of income. I agree with your total contribution result but it should be $4,275 in PS $15,000 in deferrals and $2,100 in catch-ups.

[Bird]

I thought that according to Code Section 414(v)(3)(A)(i) that catch-up contributions were not subject to the limitations under 415(c ).

I don't know who/what you're responding to. If it's something I said please expand. I determined catchups by applying 415 but did not limit them under 415, I just limited deferrals to 100% of compensation.

I agree with your total contribution result but it should be $4,275 in PS $15,000 in deferrals and $2,100 in catch-ups.

But 4275+15000=19275, more than 100% of compensation (17100). That exceeds 415, so we have to recharacterize the excess (19275-17100=2175) as a catchup, so the total catchup is 4275. I directly determined in earlier post that 100% of the catchup was a 415 excess, but I think you could look at it as 2100 being a 402(g) excess and 2175 being 415 excess.

Still disagree?

[Blinky the 3-eyed Fish]

Yep, you are right.

[Guest crosseyetester]

I'm looking for some advice on a similar but different calculation. The professional corporation plan is cross tested with an integrated formula of 5% up to the Wage Base + 20% of compensation in excess of the Wage Base. The plan has Partners whose calculation is a little different because they are self employed. My question is just regarding the partners.

Once 1/2 taxes and 401(k) is taken out of the plan, we have their applicable earnings. How do I calculate the denominator?

The client has suggested we do it as so:

$94,200 * .05 / 1.2 = $3,925

+

(Earnings - 94,200) = $125,800 Max * .2 / 1.2 = $20,967 Max

Total max ps contribution would be $24,892

Is that correct? What if the excess part of the formula was 18%, how would I run through the calculation?

Thank you.

[Bird]

The professional corporation plan

The plan has Partners

Those two phrases seem to be contradictory, but I guess we'll assume it's not a corp.

an integrated formula of 5% up to the Wage Base + 20% of compensation in excess of the Wage Base.

You've just described a money purchase formula.

Once 1/2 taxes and 401(k) is taken out of the plan

401(k) contributions don't reduce their income for profit sharing allocation purposes.

If their income is going to be over $220,000 after subtracting contributions, then just use $220,000 in your calcs. If not...you really need a spreadsheet or program to do all of the interconnected calcs, including taking non-partners' contributions into consideration, if it really is a profit sharing plan.

It appears that you're trying to take maximum plan comp and then subtract contributions to determine allocation compensation and that's wrong.

[Guest crosseyetester]

Bird,

Thank you for your response. First off I am aware that I am beyond my limited expertise on this.

Yes, you are correct, it is not a corporation. To be more specific it is a law firm. Previously, they had a 401(k) plan and an HR10 plan which were merged into a Profit Sharing Plan to cover both partners and non-partners.

Regarding 401(k) contributions, it's quite possible I am confused. Upon further research, I see that it is net business profits prior to 401(k) that is used for calculating the maximum profit sharing, with limits that it be no more than half of the net profits (since it will be subtracted and cannot be more than 100% of comp) and limited to the $44,000 limit when added to 401(k).

For Partners at the max comp limit, if they made the maximum 401(k) of $15,000, then their ps contribution will be limited to $29,000. Would a partner who did not make the max 401(k) therefore be allocated more profit sharing to bring their total contributions up to $44,000?

Because the general formula is 5% to twb + 20% of excess, there will not be a 25% of eligible comp restriction, so do I still need to take non-partner comp into question?

Finally, unfortunately, not all partners are the comp limit. Based on what you are saying though, we would still take the first $94,200 and multiply it by 5% (no denominator) and then add 20% times the comp over wage base (also no denominator). This is as opposed to the client's suggestion that you divide by factors by 1.2.

[Bird]

I think you're going in the right direction, but I still have an issue with your statement that the formula is 5% to twb + 20% of excess. It's not impossible to have a fixed formula like that in a 401(k) plan but I'm guessing that it's really 20% of excess plus anything left over is allocated pro rata (and they're shooting for 5% for the anyone under the twb); is that correct?

Yes, partners who haven't maxed out on 401(k) can wind up with more than $29,000 PS.

Here are the steps you should be going through (from a Larry Starr outline):

Start with each partner's total self-employment income before any plan contributions (including non-partners').

Subtract the partner's share of employee allocations (you immediately have an interdependency problem with profit sharing calcs at this point, because the partners' ultimate plan income for allocation purposes is dependent upon the non-partners' contributions - but if you have a money-purchase formula or are trying to get to a fixed formula as you seem to be doing, you can calc the non-partner contributions and subtract them).

Subtract Sec. 179 expenses claimed, if applicable, and any unreimbursed partnership expenses claimed.

Take the resulting number and subtract 1/2 of social security and medicare taxes.

Calc and subtract the partners' own plan contribution. (again, a circular calc but this one can be solved algebraicly (sp?) or in a spreadsheet without too much difficulty). As noted, for partners who will have $220,000 or more after this reduction, just use $220K.

The resulting number is "net earned income" i.e. compensation for plan purposes. If you run your calcs again using this number you should get the same contribution amount.