Sole prop DB cost exceeds income - deferrals allowed?

[Belgarath]

Sole prop has Schedule C income of $50,000. Has both a DB and a 401(k) plan. DB cost is $70,000.

I've always understood that this brings his income to zero, so he can't make any 401(k) deferrals. Am I crazy? If he already made them, I assume they must be refunded?

I'm having a bad morning. Driving in to work, with temperatures in the single digits and close to 2 feet of hard packed snow on the ground, I turned on the radio and the Red Sox were playing (behind already!) Major league baseball, under way in Japan, with March still roaring like a lion. This surrealistic start has left me completely off balance.

[BG5150]

Can he just re-characterize them for '08?

[Mike Preston]

But they won! That should make up, in theory, for the fact that you now have to process a refund. 415 violation and all that Jazz.

[AndyH]

Hold yee cold horsees. Can't you do the flip flop funding method (designed by those on the left coast with sandals and no snow).

Contribute $30K or so by 4/15 and file without extension. Fund the remainder by 9/15 and it is deductible next year me thinks (if the goofball makes enough $$$), and the guy still has enough income to support the deferral this year.

What am I missing? Is there a special rule for sole prop's that prevents this that I am unaware of?

[Mike Preston]

No special rule and it would work if we knew what the IRS' position is going to be with respect to what are referred to as "includable contributions" in the regs. There is some talk of eliminating them entirely and just relying on the annual calculations as defined under PPA for the minimums and maximums. If you want to potentially use $40k or so of your 2008 maximums by flipping or flopping, go for it.

Actually, it sounds like the right move, all things considered.

[Belgarath]

Thanks! But why can't he still have an extension? There's no automatic override of the 404 default (that the contribution is deductible in the fiscal year when paid UNLESS you choose to use the 404(a)(6) period) is there?

[AndyH]

Thanks! But why can't he still have an extension? There's no automatic override of the 404 default (that the contribution is deductible in the fiscal year when paid UNLESS you choose to use the 404(a)(6) period) is there?

If it is paid in time to be deductible, then it reduces comp. If an extension is filed, and the contribution is deposited by the due date for the filing, it is deductible. If it is contributed after the filing due date, it is not currently deductible. But you want it deposited by 9/15 either way to avoid a funding deficiency.

I'm not sure how long the extension runs to. If only 8/15 then you can still play the same game and make the deposit between 8/16 and 9/15 (or whatever part of the deposit you want to deduct for 07).

One more thing, though. Under the pre-PPA rules - and please take note of Mike's useful caution - next year the deductible amount would be limited to the non-deducted contributon for 2007 plus the minimum for 2008. So you may lose some flexibility for 08.