Nondeductible contribution to sole proprietor DB plan

[Guest Pennysaver]

As a result of the minimum funding standard, a sole proprietor contributes more to her DB plan than 100% of her earned income. The sole proprietor is the only participant. Since the amount contributed in excess of 100% of her earned income is nondeductible, does the nondeductible portion of the contribution result in basis to the sole proprietor?

[Andy the Actuary]

As a result of the minimum funding standard, a sole proprietor contributes more to her DB plan than 100% of her earned income. The sole proprietor is the only participant. Since the amount contributed in excess of 100% of her earned income is nondeductible, does the nondeductible portion of the contribution result in basis to the sole proprietor?

A few years ago, one of my clients (an attorney no less) opined that IRC 1.72-17 applied and his interpretation was that the excess contribution was non-taxable.

Sharing this should not be construed that I am confirming or supporting this position as I am not a tax accountant and am well versed only in actuarialese, baseball, and good, cheap, and plentiful dining.

[Guest Sieve]

. . . and hockey.

[Guest Pennysaver]

As a result of the minimum funding standard, a sole proprietor contributes more to her DB plan than 100% of her earned income. The sole proprietor is the only participant. Since the amount contributed in excess of 100% of her earned income is nondeductible, does the nondeductible portion of the contribution result in basis to the sole proprietor?

A few years ago, one of my clients (an attorney no less) opined that IRC 1.72-17 applied and his interpretation was that the excess contribution was non-taxable.

Sharing this should not be construed that I am confirming or supporting this position as I am not a tax accountant and am well versed only in actuarialese, baseball, and good, cheap, and plentiful dining.

Thanks, Andy, but I have read through 1.72-17 and I am not seeing how it applies. The nondeductible contributions aren't excess contributions (that is, they aren't in excess of the benefits provided for under the plan formula). They are required due to the minimum funding standard and are only nondeductible because they exceed 100% of the sole proprietor's earned income. Since these nondeductible contributions can't be carried forward under IRC 404(a)(1)(E), what is the taxable effect to the sole proprietor as a participant?

[Andy the Actuary]

Sorry, as they sang about Kansas City, "I've gone 'bout as fer as I kin go."

[tymesup]

There was an extensive discussion of this issue on the COPA board, with no consensus answer, fwiw.

[Belgarath]

Rightly or wrongly, many folks and their CPA's carry this forward and deduct it in later years. I haven't seen an IRS audit on one of these, so I don't know what they would say.

[Guest PiggyBank]

Andy's client appears to be correct. See the example under Treasury Regulation §1.72-17(b)(6), which discusses the basis a self-employed individual has in the amount contributed under the qualified pension plan on his behalf while he was an owner-employee but which was not allowed as a deduction.

Whether the contributions are excess contributions or simply contributions in excess of the deduction limit under Code Section 404 would appear to be irrelevant. See Treasury Regulation §1.72-17(b)(2), which provides that the taxable amount of the distribution cannot exceed the aggregate amount that was deductible under Code Section 404 when contributed, and Treasury Regulation §1.72-17(b)(3), which provides that any amounts to which Treasury Regulation §1.72-17(b) applies which are not includible in gross income pursuant to Treasury Regulation §1.72-17(b)(2) shall be subject to Code Section 72(e) and Treasury Regulation §1.72-11.

[Belgarath]

Ok, so I think I've got it on this if you take the approach that the contribution can't be carried over and deducted in a leter year.

1.Due to 4972©(4), there's no excise tax on the nondeductible contribution amount.

2. And due to 1.72-17(b), as referenced earlier, the nondeductible amount is non-taxable basis when received.

Have I got that right? Seems like this is at least a reasonable and consistent result.