Adjusted Compensation for 1/2 SE tax

[emmetttrudy]

DB Plan (one person) was originally effective 1/1/2011, BOY valuation. Average compensation is being calculated at 1/1/2011 using K-1 compensation for a sole prop for the years 2008, 2009 and 2010. Normally the compensation for valuation purposes is adjusted for contributions made and 1/2 SE tax. Obviously in the years 2008 through 2010 there were no contributions because the plan did not exist. Does the compensation for those years need to be adjusted for 1/2 SE tax? Or can the Average Compensation for the 1/1/2011 valuation be calculated using the net income from Schedule K-1 with no adjustments because there was no plan for those years?

[Andy the Actuary]

401©(2)(A)(vi) does not require that a plan be in place. I'm unaware of any overiding provision.

[tymesup]

Check the plan document's definition of Earned Income. It may mention the SE tax deduction.

[SoCalActuary]

DB Plan (one person) was originally effective 1/1/2011, BOY valuation. Average compensation is being calculated at 1/1/2011 using K-1 compensation for a sole prop for the years 2008, 2009 and 2010. Normally the compensation for valuation purposes is adjusted for contributions made and 1/2 SE tax. Obviously in the years 2008 through 2010 there were no contributions because the plan did not exist. Does the compensation for those years need to be adjusted for 1/2 SE tax? Or can the Average Compensation for the 1/1/2011 valuation be calculated using the net income from Schedule K-1 with no adjustments because there was no plan for those years?

The Code is pretty clear on this. If you want to use the prior year histories, you need the info on the front of the 1040, the SE form, and if it is a joint return, you need the separate amounts for each spouse.

How do you know what adjustments were made in the past? Are you willing to put your client at risk because you did not perform your due diligence? These items do get audited.

[Guest AP914]

DB Plan (one person) was originally effective 1/1/2011, BOY valuation. Average compensation is being calculated at 1/1/2011 using K-1 compensation for a sole prop for the years 2008, 2009 and 2010. Normally the compensation for valuation purposes is adjusted for contributions made and 1/2 SE tax. Obviously in the years 2008 through 2010 there were no contributions because the plan did not exist. Does the compensation for those years need to be adjusted for 1/2 SE tax? Or can the Average Compensation for the 1/1/2011 valuation be calculated using the net income from Schedule K-1 with no adjustments because there was no plan for those years?

The Code is pretty clear on this. If you want to use the prior year histories, you need the info on the front of the 1040, the SE form, and if it is a joint return, you need the separate amounts for each spouse.

How do you know what adjustments were made in the past? Are you willing to put your client at risk because you did not perform your due diligence? These items do get audited.

SoCal, I am not questioning you, but could you provide Code section you are referring to? Thanks in advance!

[SoCalActuary]

Would like to help you with the tax research, but the issue is simple.

You want to use compensation for plan purposes based on prior years.

Each of those compensation amounts must meet the definition of earned income.

None of those years provided any exemption from the general rules that earned income is adjusted for self-employment tax and employer -provided retirement contributions.

[frizzyguy]

I agree with SoCal. The same reason you need to subtract it in the current year is the same reason you have to subtract it in years before the plan begins. I am confused as to why the plan being in place matter.

Also, I believe you need to take into account contributions made to other plans as well. SoCal, do you agree with that too?

[SoCalActuary]

I agree with SoCal. The same reason you need to subtract it in the current year is the same reason you have to subtract it in years before the plan begins. I am confused as to why the plan being in place matter.

Also, I believe you need to take into account contributions made to other plans as well. SoCal, do you agree with that too?

Yes. The more complex detail of 1402 rules and 1.401-10 regulations also discuss this. Which companies produced the income? Are they adopting employers? Did they have reductions to earned income for those contributions?

If you don't know the answers to these questions, how do you know what compensation to count?

[mwyatt]

Also want to keep in mind that in 2010 at least was tinkering for SEHI on the Self-Employment Tax computation for the 1040. IRS's position was that for pension purposes you ignore this and just do your computation as before. You will also want to check for any W-2 income potentially in those years when doing your calcs.