Earned Income Calc

[austin3515]

This was in the May 2008 IRS Q&A from the ABA:

12. § 401©(2) – Self Employed Individuals Earned Income Treas. Reg. § 1.415©-2(b) defines compensation for self-employed persons as earned income under § 401©(2) of the Code, plus amounts deferred at the election of the employee under § 401(k) of the Code. Earned income under § 401©(2) of the Code includes a reduction for 50% of SECA liability. When is SECA liability determined?

Proposed Response: The SECA liability should be determined after the 401(k) contributions have been deducted from the person’s income. The 401(k) contributions are then added back to arrive at 415 compensation.

IRS Response: The Service representative agrees with the proposed response.

Is anyone calculating the 50% deduction for SE Taxes on comp NET of 401(k)?

[J Simmons]

So, per this Q&A, for the self-employed, SECA (the FICA equivalent) applies to employer contributions but not the self-employed's 401k elective deferrals.

But for employees, FICA applies to 401k elective deferrals but not employer contributions.

I don't get it.

[R. Butler]

See GCM 39807. It sets for forth the IRS position on this issue.

http://www.legalbitstream.com/scripts/isys...ry/irl6dc/1/doc

[Bird]

Is anyone calculating the 50% deduction for SE Taxes on comp NET of 401(k)?

No.

I'm not sure what GCM is saying, and I'm not sure it applies to 401(k) deferrals. Translation?

[R. Butler]

From the GCM --

For employees, elective contributions to a section 401 (k) plan or to a section 408(k)(6) SEP are includible in the FICA wage base under sections 3121(v)(1) and 3121(a)(5)©, respectively. However, elective contributions to a qualified plan containing a 401 (k) arrangement or to a salary reduction SEP on behalf of a self-employed individual are not “wages” for FICA tax purposes, since the self-employed individual is not an “employee” for FICA tax purposes. Furthermore, as in the case of nonelective contributions by an employer to a qualified plan or SEP on behalf of a self-employed individual, elective contributions to such plan or SEP on behalf of the self-employed individual are not attributable to his or her trade or business. Accordingly, such contributions do not generate a deduction from gross income for SECA tax purposes under section 1402(a).

[austin3515]

Thanks for the link R Butler!

I now understand the logic behind what I've always been doing. I have always thought it was strange that they didn't get a deduction for the employer contriubtion (i.e., because if it was a c-corp that bonused out all income, the c-corp owner would not pay FICA/SECA on those amounts). I still think its a silly conclusion, but at least now I understand the logic.

It seems clear that the Q&A is either incorrect or very very misleading.

[Don Levit]

R. Butler:

That was a very helpful GCM.

It described, as you mentioned, the mechanics of why SECA must be paid, while income tax is not due.

"The fact that the underlying expense for a self-employed individual is treated as a trade or business expense for income tax purposes is relevant, but not necessarily conclusive, for determining whether the deduction is also one attributable to such trade or busibess for SECA tax purposes."

"The deduction is taken as an adjustment to income on the Form 1040, and is not taken as a deduction from the self-employed individual's Schedule C income or from the computation to determine the self-employment tax on the schedule SE, Form 1040."

"A deduction under SECA for contributions to a qualified plan is disallowed because it is not attributable to a trade or business."

TAM 200305006 takes another unique approach to the payment of income and Social Security taxes in regards to qualified plans."

"That broad interpretation of wages has justified the concept that in this context, wages for FICA tax purposes is a broader term than income for income tax purposes.

Thus, even though employer contributions to a section 403(b) annuity are excludable from gross income, such contributions are subject to FICA taxes if they are made by a salary reduction agreement."

"The Social Security program aims to replace the income of beneficiaries when that income is reduced on account of retirement and disability.

Since the Social Security system has objectives which are significantly different from the objective underlying the income tax withholding rules, the committee believes that amounts exempt from income tax withholding should not be exempt from FICA unless Congress provides an explicit FICA tax exclusion."

Don Levit

[R. Butler]

The interesting thing on the TAM is that the 403(b) contribs were compulsary.

[Don Levit]

R. Butler:

Do you mean that compulsory contributions should also be exempt from FICA?

Don Levit

[R. Butler]

R. Butler:

Do you mean that compulsory contributions should also be exempt from FICA?

Don Levit

Not necessarily; just the argument the employer set forth was interesting. The employer did not dispute that salary reduction contributions are subject FICA, the employer disputed whether compulsary contributions were in fact salary reduction contributions.