Sole-Prop Non-Deductible Contributions

[Rob P]

A sole-prop has a requirement minimum contribution greater than their earned income for 2008. So part of the contribution is currently non-deductible.

Just a theoretical question: What would happen if they never have future earned income and never get a chance to take the deduction on the whole 2008 contribution?

For example, for 2008 the sole-prop has a $150K required contribution and can only deduct $100K. In 2009, the sole-prop’s source of income dries-up and they don’t anticipate any future income. So in 2009, the sole-prop elects to terminate the plan and rollover their entire benefit to an IRA.

What happens to the $50K non-deductible amount? Can it be rolled over? If they elect a taxable distribution is it subject to tax?

Any thoughts are appreciated.

[Andy the Actuary]

The following relates what a former client did. Thus, your client would need to seek his own tax counsel.

The former client, who is an attorney, dragged out some ancient annuity basis rules under IRS 1.72 from which he deduced that when he started to take his distribution from the IRA, part of the distribution would constitute a non-taxable basis.

As far as what can be rolled, that is on the other side of the fence and is based upon his benefit under the plan. If the referenced attorney's basis supposition doesn't fly, he will have contributed after-tax dollars and then be taxed again when he takes an IRA distribution.