Calculation of earned income for sole prop or partnership

[jkdoll2]

When calculating the earned income for a sole prop or partner in a partnership in a 401(k) plan I have been using a spreadsheet that includes a reduction for the employee's salary deferrals. (i.e. earned income minus 1/2 SE tax, minus employee deferrals and employee's employer contribution, minus the sole prop/partner employer contribution.

Argument is subtracting the employees deferrals. Our software company does not do that - has that changed?

Do you subtract the employees deferrals (not owners deferrals) to determine the comp for the sole prop or partnership?

This is for earned income only - not for deduction purposes.

Thanks

[frizzyguy]

When calculating the earned income for a sole prop or partner in a partnership in a 401(k) plan I have been using a spreadsheet that includes a reduction for the employee's salary deferrals. (i.e. earned income minus 1/2 SE tax, minus employee deferrals and employee's employer contribution, minus the sole prop/partner employer contribution.

Argument is subtracting the employees deferrals. Our software company does not do that - has that changed?

Do you subtract the employees deferrals (not owners deferrals) to determine the comp for the sole prop or partnership?

This is for earned income only - not for deduction purposes.

Thanks

Arguement? It's not really an arguement. Deferrals aren't subtracted for earned income. They are part of the overall deduction limit though. You can't deduct more than the total of your formula above but the compensation used in the DB plan formula doesn't subtract deferrals. That's why your software doesn't do it.

[DMcGovern]

In the ERISA Outline Book, Ch. 1A, Part A, 3.c. – “If the sole proprietorship or partnership has common law employees who are covered by the plan, the qualified plan deduction under IRC Section 404 that is taken into account to compute earned income includes the contributions made on behalf of such employees (or, in the case of a partner, the partner’s allocable share of the deduction attributable to such contributions), including the elective deferrals made by such common law employees to a 401(k) arrangement maintained by the employer…..The elective deferrals made by the common law employees are part of the employer contributions deducted by the employer (i.e. the sole proprietor, or the partnership, as the case may be) under IRC Section 404.”

In addition, in the ASPPA DC 3 study guide Chapter 2 there is an example for the effect of elective deferrals on the self-employed individual’s earned income, “Jimmy’s earned income is reduced by the contributions made on behalf of the other employees (both elective deferrals and employer profit sharing contributions). It is further reduced by the profit sharing contribution made on Jimmy’s own behalf, but not for his elective deferrals.”

[SoCalActuary]

On top of the other comments, you don't use 1/2 the tax. You use the EMPLOYER portion, which does not have the 2% welfare-level stimulus that only lowers taxes on workers.

The spreadsheet is seriously out of date.

Look at the IRS Pub 560, which shows how to treat the deferrals when computing a DC plan.

[DMcGovern]

From IRS Publication 560:

"Net earnings from self-employment. For SEP and qualified plans, net earnings from self-employment is your gross income from your trade or business (provided your personal services are a material income-producing factor) minus allowable business deductions. Allowable deductions include contributions to SEP and qualified plans for common-law employees and the deduction allowed for the deductible part of your self-employment tax."

As I mentioned in my previous post, the contributions to a qualified plan for common-law employees INCLUDES salary deferrals.

[SoCalActuary]

From IRS Publication 560:

"Net earnings from self-employment. For SEP and qualified plans, net earnings from self-employment is your gross income from your trade or business (provided your personal services are a material income-producing factor) minus allowable business deductions. Allowable deductions include contributions to SEP and qualified plans for common-law employees and the deduction allowed for the deductible part of your self-employment tax."

As I mentioned in my previous post, the contributions to a qualified plan for common-law employees INCLUDES salary deferrals.

The deferrals of non-owner employees are shown on the Schedule C as payroll. Employee deferrals come out of their wages, and you don't deduct them twice.

Owner deferrals do not come out of Schedule C as deductions. They appear on the front of 1040.

[frizzyguy]

The maximum allowable deduction takes into account deferrals but they do not get subtracted for the compensation in the DB formula. Deferrals are NOT a business expense. They are an individual expense.

[frizzyguy]

Also, I keep saying 1/2 SE out of habit, I really should be saying the employer portion of the SE tax because of the recent adjustment to FICA that will probably be going away. It is the SE deduction from page 1 of the 1040. I keep stating it wrong, sorry SoCal. Per the usual, you are spot on.

Check out ERISA Outline Book, Ch. 1A, Part A, 3b. The whole section is applicable.

For the plan formula, you don't take out deferrals but for overall deductions, you can't go over 100% of pay.