Pension Plan for Self-Employed

[Gary]

A husband and wife are the only partners of an LLC.

Say they each receive separate Schedules K-1 of 100k each.

For the husband the entire k-1 of 100k is subject to SE taxes.

For the wife 20k is subject to SE taxes and 80k is not subject to SE taxes, presumably passive income.

As a result there is a total of 200k of k-1 net income.

It would appear that the 120k that is subject to SE taxes, i.e. earned income would be eligible for pension purposes where a total of 120k could be deducted.

Is there a rational (any interpretations) for providing that all 200k can be deducted? That is, where 50% SE taxes plus imputed pension compensation plus the pension deduction add up to 200k? Or are we still limited to the 120k portion and the 80k cannot be considered in the equation at all.

Thanks.

[Mike Preston]

I've always operated under the presumption that the maximum deduction under 404 is limited to net earned income. I would be surprised if any other kind of income, such as the passive income of $80k you've described, would allow the deduction under 404 to exceed net earned income.

[Gary]

I agree with your response.

Playing devil's advocate.

What if instead the spouse were treated as an employee, where the 20k was w-2 salary from the LLC and the 80k profit remained in the LLC and was used to fund pension benefits for the employees? i.e. the spouse. Then it seems that the income could be used for a pension deduction.

[Mike Preston]

You'd have to check with an accountant to see if there are (or are not) any rules that would scuttle that approach. Something tells me that passive income in the corporation will be subject to different rules, but then again, maybe not.

[Gary]

Thanks.

Another related aspect that I have wrestled with is:

Say a person has K-1 earned income of 200k.

Can the person use this 200k to divide between notional compensation for him, notional compensation for his spouse, 50% SE tax deduction, and the remaining amount as a pension contribution.

For eg.

Husband notional comp =25k

Wife notional comp = 25k

Approx. 50% SE deduction = 10k

Pension cont = 140k

Therefore, 25k + 25k + 10k + 140k = 200k

That is, can earned income f be split between husband and wife or is a separate k-1 of earned income for the wife necessary?

[SoCalActuary]

separate k-1 required as a partner, or w-2 as an employee