Pension for sole proprietor

[Gary]

Say we have a sole proprietorship, where the husband owns the company and the wife is an employee (or it can be a non wife employee).

Point being, we have owner and one employee.

The owner files a Schedule C.

The pension costs for the employee are a Schedule C deduction and the net earned income flows to the owner's Form 1040 where the earned income is allocated between:

notional pension compensation

pension deduction

50% SE tax deduction.

Does anyone have a standard technique of dividing the employee pension cost and the owner pension cost?

Assuming PPA funding calculation.

Do people use the increase in PVAB as a ratio? Or the PVAB at the end of the year as a ratio?

Or perhaps the PVAB at beginning of year less assets (where assets are allocated by ratio of PVAB) and then add increase in PVAB and use the ratio of that sum?

Thanks.

[Andy the Actuary]

Forget PPA, how were you allocating cost previously where the Plan employed an immediate gain method? Didn't do that? So, what did you do when the Plan employed the IA method but employer contributed more than the minimum?

One approach is (even before PPA) to assume the employees' benefits were fully funded so that any contributions in excess of the normal cost (whether it be IA or EAN) were attributed to the employer. Thus, for example, the amortization of gains/losses affected the employer and not the employee. After all, if the Plan were terminated and was unfunded, the owner-employer would take the hit.

[mwyatt]

So in essence (given the 2 person scenario here), anything in excess of the 430 minimum cost for the spouse (her target normal cost plus her allocated share of SB payment/reduction) is attributed to the owner?

[Andy the Actuary]

So in essence (given the 2 person scenario here), anything in excess of the 430 minimum cost for the spouse (her target normal cost plus her allocated share of SB payment/reduction) is attributed to the owner?

The suggestion is that there is no allocation per se, that the spouse's benefit was fully funded. It is an approach but certainly not the only approach. Are you aware of printed guidance that indicates the amortization must be allocated?

[mwyatt]

No regulation, but if the employee has an accrued benefit for Funding Target purposes, would think it logical (albeit a little convoluted to accurately apportion given length of time participating) that any credit or base would be attributed to them as well as the principal.

[Andy the Actuary]

No regulation, but if the employee has an accrued benefit for Funding Target purposes, would think it logical (albeit a little convoluted to accurately apportion given length of time participating) that any credit or base would be attributed to them as well as the principal.

That certainly defines another approach.

[tymesup]

We've been allocating contributions by Target Normal +/- (Amortization and Cushion), not that there's a right answer.

The owner gets a bigger total deduction if the employee contribution is smaller, unless the owner is already maxing out on comp or benefits.

Some software will come up with an allocation between earned income, owner deduction and employee deduction on a minimum basis. I would avoid using the maximum contribution based on this allocation, as you are funding for a compensation/benefit that may not exist.

[Andy the Actuary]

Would like to revisit where the Plan has an owner employee and two staff nonowners and further the Plan was frozen 12/31/2007 and underfunded (about 60%). There is no TNC. There is only an amortization.

(Notwithstanding opinioins on whether or not distribution could be made upon termination) I would argue that if the Plan temrinated, the staff would get their full benefit and the owner employee would take the hit. Thus, the entire contribution would be deducted on 1040 and there would be no allocation to Schedule C. This position would not necessarily be in the best interests of the owner employee owing to selfemployment tax on any portion that would otherwise be allocated to the employees. Of course, in this situation if we allocated the gains/losses (say based upon FT) most would go on 1040 owing to the relative size of the FTs!

Any thoughts?