401k for passthrough LLC

[Guest markol]

Hello,

I come to you for advice.

I, and a partner, are owners of a small business that is an LLC filing as a partnership. All income is pass-through. Each partner has a 50% stake in the venture. We have 7 employees/contractors. During the 2008 year, business made a large-ish profit where tax exposure is quite considerable. During that time partner A was paid lets say $40k (straight cash - no tax withheld or declared to IRS assuming all will get calculated in April) and partner B got $0 (nothing). Neither partner is on W-2. All profits were re-invested back into the business.

We are looking to diminish our tax exposure for the year by creating 401k accounts and contributing to it to the maximum. Is this allowed based on tax law. We are getting conflicting advice from various sources. Our accountant states that as partners we are not w-2 but as K-1, and since we are not w-2 and get "guaranteed payments" instead of salary, are not allowed to contribute to 401k. Fidelity, ING, and other phone support people beg to differ and want us to contribute full amounts with their institutions. They are claiming that LLC is same as anything else and can write off 401k contributions from the K-1, for partners, employees or whatever and we can contribute regardless.

Please share your experience in this matter. Links to relevant supporting documentation would be greatly appreciated.

[Bill Presson]

You need a new accountant.

[Lou S.]

Will the partners have earned income for self-employement tax purposes. If not, you have no pensionable income.

[QDROphile]

I agree that your accountant should be able to do better, but you may still be stuck if you have not adopted a 401(k) plan already and you have employees. Your employees won't have much of an opportunity for elective deferrals for what is left of 2008 so you will have discrimination problems. If your your tax avoidance motivation is matched by generosity, you could adopt a plan and contribute amounts for all partners and employees within the tolerances of the discriminatin rules, which can work out quite well for the partners and have a reasonable cost for the employee benefits.

[rcline46]

First, your accountant does not know 'Earned Income' from 'W-2' income. That is why accountants are not pension professionals.

Second, as said above, you and your partner will need 'Earned Income' of a positive nature on your K-1s in order to make any deductible contributions. YOu will need to act fast to have a Qualified plan established (signed!) by 12/31/08. A SEPP you can establish for 2008 up until at least April 2009, but you need to know the advantages and disadvantages of IRA plans VS Qualified Plans.

I believe www.asppa.org will provide you a list of firms in your area, or your business contacts may tell you who they like for firms to take care of your plan. Good luck!

[jpod]

I thought of the "earned income" issue too, initially, but the OP said there are guaranteed payments, which clearly qualify as earned income.

[Guest markol]

Will the partners have earned income for self-employement tax purposes. If not, you have no pensionable income.

I am not sure what you mean here. We can classify the income that was given to the partners however we want since nothing has been posted to IRS yet. Though again any money that passes from the company to partners is classified as guaranteed payments according to our accountant.

Partner B, the one who got nothing from the business had a side job during the time with plenty of income.

I am not so concerned over the discrimination part. There is a fairly decent sounding scheme that was recommended by the Fidelity guys.

Does this change anything?

[Bird]

Prior posts are on target...your accountant is flat-out wrong, and it's probably too late to do anything for 2008.

To clarify one point a bit - the starting point for "compensation" for plan purposes is your "self-employment income." That's typically going to be your profits, or at least pretty close (there are some non-"earned" items that need to be adjusted out but that's probably not relevant here). If you took draws of $100,000, and your profits are $110,000, then $110,000 is your self-employment income - the draws are just advances and don't affect your tax picture. If you took draws of $100,000 and your profits are $80,000, then $80,000 is your self-employment income - again, the draws are irrelevant to your tax picture. There are further adjustments for self-employment taxes paid, and also for any company contributions made to the retirement plan, but for the moment let's ignore that. Yes, you can make 401(k) contributions from this income, but 401(k) contributions are subject to a a non-discrimination test, and if you and your partner are the only ones contributing in 2008, which at this point is the likely scenario, you'd have to take most or all of the money back as taxable income.

There is one thing that might be possible for 2008 - if you and your partner started the business in a prior year, say 2007, and your employees started in 2008, you could establish a Simplified Employee Plan and have an eligibility requirement that only includes in 2008 contributions those who were employed in a prior year (2007). The limit is 25% of compensation (roughly 20% of your profits). It can be established as late as your tax return due date in 2009.

Finally, you mention "employees/contractors." True independent contractors are not employees and wouldn't be in a plan that you sponsor...but a lot of people are mis-classifying employees as independent contractors.

OK, one more thing - do yourself a favor and don't think you can set up a 401(k) plan directly with Fidelity and have it work right. Contact a local third party administrator, and ask what kind of fees they would charge for handling a plan of your size. If you are scared away by the fees, then just forget about having a plan. You really need someone who knows what they are doing.

[K2retire]

OK, one more thing - do yourself a favor and don't think you can set up a 401(k) plan directly with Fidelity and have it work right. Contact a local third party administrator, and ask what kind of fees they would charge for handling a plan of your size. If you are scared away by the fees, then just forget about having a plan. You really need someone who knows what they are doing.

Especially since your accountant apparently doesn't know what he or she is doing, at least as far as retirement plans are concerned.

[rcline46]

You can start a 401(k) this year, and using the 'prior 3% rule', you and your partner can deposit up to 5% of your earned income, plus any profit sharing you want, a new comparability plan it it works. Then in 2009 (like do the amendment now!) a safe harbor plan. This is very doable.

You do need to know or have an idea what your earned income will be. There are many of us on this board who can help you.

[QDROphile]

rcline:

You are assuming the employees are excludable?

[rcline46]

If excludable, then the HCEs can defer up to the maximum. If not excludable, then the 3% rule allows at least some deferral.

[QDROphile]

Not much time left in December to defer much of anything. Does that, in an of itself, bother you?