Net Earnings from Self Employment

[Guest AJM 34]

I am working on a New Comparibilty Profit Sharing plan for two self employed partners, and 4 other employees who are paid via a W-2

Can someone please walk me thru the calculation to get to the Net Earnings from Self Employment based on the following factors:

2011 Schedule K-1 line 14A: 656,811

2011 401(k) Deferrals: 16,500

2011 Profit Sharing: 32,500

If you need any other information to do the calculation, please let me know. Any help is greatly appreciated.

[401king]

I am working on a New Comparibilty Profit Sharing plan for two self employed partners, and 4 other employees who are paid via a W-2

Can someone please walk me thru the calculation to get to the Net Earnings from Self Employment based on the following factors:

2011 Schedule K-1 line 14A: 656,811

2011 401(k) Deferrals: 16,500

2011 Profit Sharing: 32,500

If you need any other information to do the calculation, please let me know. Any help is greatly appreciated.

I think you'll need to indicate ownership percentages and company contributions to the employees.

[Kevin C]

Among our partnership clients, some apportion the employer contributions for the employees based on ownership percentages, and some use earnings. The only way to find out which one they use is to ask.

Starting with a K-1 number of $656,811 and only having 4 employees, I would expect the final plan compensation number for the partner to be over $245K. That should make it easier to figure out what the employees need to receive to satisfy the gateway and 401(a)(4) general test.

[Guest AJM 34]

I am working on a New Comparibilty Profit Sharing plan for two self employed partners, and 4 other employees who are paid via a W-2

Can someone please walk me thru the calculation to get to the Net Earnings from Self Employment based on the following factors:

2011 Schedule K-1 line 14A: 656,811

2011 401(k) Deferrals: 16,500

2011 Profit Sharing: 32,500

If you need any other information to do the calculation, please let me know. Any help is greatly appreciated.

I think you'll need to indicate ownership percentages and company contributions to the employees.

Ownership % is 50 /50 between the 2 partners and the company contribution to the employees are 7,571.35

[austin3515]

Starting with a K-1 number of $656,811 and only having 4 employees, I would expect the final plan compensation number for the partner to be over $245K. That should make it easier to figure out what the employees need to receive to satisfy the gateway and 401(a)(4) general test.

I think perhaps AJM missed the comment above.

[mbozek]

Starting with a K-1 number of $656,811 and only having 4 employees, I would expect the final plan compensation number for the partner to be over $245K. That should make it easier to figure out what the employees need to receive to satisfy the gateway and 401(a)(4) general test.

I think perhaps AJM missed the comment above.

Lets do a little math.

If 245 is comp and 32,5k is the employer contribution then the PS contribution rate for partner would be 13.25% which under the 401© rules in Pub 560 is 15.3% after taking the 32.5k deduction. (32.5/212.5)

What would % be for the two non owners?

[austin3515]

mbozek -

Are you suggesting that the allocation rate is not ~13% (32.5/245)? The starting point is 650K, so all the match you mentioned brings it down to $600K (I didn;t do the math), but it's then that you would apply the max comp limit.

I seem to recall some discussion of some obscure literal interpretation of the rules that might suggest your approach, but I have never heard of anyone actually applying the limit as you suggest.

[mbozek]

mbozek -

Are you suggesting that the allocation rate is not ~13% (32.5/245)? The starting point is 650K, so all the match you mentioned brings it down to $600K (I didn;t do the math), but it's then that you would apply the max comp limit.

I seem to recall some discussion of some obscure literal interpretation of the rules that might suggest your approach, but I have never heard of anyone actually applying the limit as you suggest.

IRC 401©(2)(A)(v) refers to earned income determined with regard to IRC 404 deductions which means that the Q plan contributions are deducted from net earnings not exceeding the 414(s) (limit (245k)) to determine earned income. See step 6 of work sheet for SE, P 22 of Pub 560. Pub 560 P 22-23 defines a 20% contribution based on net earnings to be equal to 25 % of earned income. So if a SE contributed 49k on 245k net earnings from SE the contribution rate is 25% of earned income (196k). My understanding is that if contribution for SE is 25% of earned income then contributions for W-2 employees must be 25%, not 20%. The IRS calculation in Pub 560 has been around for many years.

What I asked is what is the gateway % for W-2 employees if employer PS contribution for owner is 15% of earned income?

[Bird]

For the uninformed and/or newbies, if self-employment income before contributions is $650K, and employee and partner contributions bring earned income after contributions to $600K or so, then plan compensation for the partner is $245K, and the contribution rate is 32.5/245 = 13.26...%. Absolutely no doubt about it. I didn't look (again) at the IRS Pub cited, but it is either wrong or makes simplifying assumptions that are mis-applied if used in situations such as this one.

[austin3515]

I would like to point out that no one does it any other way, at least that I have ever met (I can say that having never met mbozek).

[mbozek]

For the uninformed and/or newbies, if self-employment income before contributions is $650K, and employee and partner contributions bring earned income after contributions to $600K or so, then plan compensation for the partner is $245K, and the contribution rate is 32.5/245 = 13.26...%. Absolutely no doubt about it. I didn't look (again) at the IRS Pub cited, but it is either wrong or makes simplifying assumptions that are mis-applied if used in situations such as this one.

What is your substantial authority for saying the IRS methology in Pub 560 P22-23 is wrong. Example: P23 if plan contribution rate is 13%, rate for SE person is 11.5%.

At bottom of rate table for self employed on P 23 has this statement for 25% plan contribution for SE:

column A

If plan contributon

rate is

25%*

Column B

your contribution rate is

20%

*The deduction for annual employer contributions (other than elective deferals) to a SEP, a profit sharing or money purchase plan cannot be more than 20% of your net earnings (figured without deducting contributions for yourself) from the business that has the plan.

[mbozek]

I would like to point out that no one does it any other way, at least that I have ever met (I can say that having never met mbozek).

Every text follows IRS methology. However, tax preparers like to do their own thing and disregard IRS rules. For example some CPAs deduct retirement plan contributions for SE persons on sked C with contributions for employees instead of on Line 28 lof 1040 because this reduces SECA tax on net earnings on form SE. I dont prepare taxes so I dont care what they do.

[Bird]

What is your substantial authority for saying the IRS methology in Pub 560 P22-23 is wrong. Example: P23 if plan contribution rate is 13%, rate for SE person is 11.5%.

I don't have any, other than experience and knowledge; and as Austin notes, there isn't any real dispute about it.

The time I want to spend on this was used up a while ago; readers will have to make their own decisions. But just looking at the text posted from the Pub, I can see that they are short-cutting the calcs and telling a self-employed that they are assuming equal (and maximum) contributions and basing the calcs on net earnings from self-employment before the self-employed's contributions, and the applicable percentage indeed is 20%.

[mbozek]

What is your substantial authority for saying the IRS methology in Pub 560 P22-23 is wrong. Example: P23 if plan contribution rate is 13%, rate for SE person is 11.5%.

I don't have any, other than experience and knowledge; and as Austin notes, there isn't any real dispute about it.

The time I want to spend on this was used up a while ago; readers will have to make their own decisions. But just looking at the text posted from the Pub, I can see that they are short-cutting the calcs and telling a self-employed that they are assuming equal (and maximum) contributions and basing the calcs on net earnings from self-employment before the self-employed's contributions, and the applicable percentage indeed is 20%.

If there is no dispute that you are correct and the IRS is wrong why cant you or Austin provide any authority for your position? Should be easy to prove the IRS is wrong since IRC 401© has been around for 50 years and there would be a lot of professional comment on why the IRS is wrong.

See below quote from attached link to IRS publication on Avoiding Incorrect Self employed Retirement deductions:

"Deduction limits for the self employed

If you contribute to your own SEP-IRA, you must make a special computation to figure your maximum deduction for these contributions. When figuring the deduction for contributions made to your own SEP-IRA, compensation is your net earnings from self-employment which takes into account both of the following deductions:

Deduction for one-half of your self-employment tax.

Deduction for contributions to your own SEP-IRA."

http://www.irs.gov/newsroom/article/0,,id=188218,00.html

If 1/2 of the SECA tax must be deducted from net earnings from self employment then the contribution to the owners SEP must also be deducted.

[austin3515]

IRC 401©(2)(A)(v) refers to earned income determined with regard to IRC 404 deductions which means that the Q plan contributions are deducted from net earnings not exceeding the 414(s) (limit (245k))

To me, this logic equates to the same kind of tenuous logic used to conclude that forfeitures cannot be used to reduce Safe Harbor contributions and QNEC's. OK, I can see the basis for the conclusion (401© refers to 404, 404 to 414, 414 to 401a17), but that seems way too indirect to ignore commonly accepted understandings of the rules which have been consistently applied for the same 30 year period you reference, UNTIL the IRS issues formal guidance to the contrary (as they chose to do with QNEC's/forfeitures).

In fact, Line 6 of the worksheet reads "Multiply $230,000 by your plan contribution rate (not the reduced rate)" which I believe supports our position that no reduction below the max comp limit is required. Wait a miniute, if you put $650,000 on Line one of the worksheet, won't you get the outcome we are suggesting??

Please let me know how the worksheet comes up with a different result here.

[mbozek]

IRC 401©(2)(A)(v) refers to earned income determined with regard to IRC 404 deductions which means that the Q plan contributions are deducted from net earnings not exceeding the 414(s) (limit (245k))

To me, this logic equates to the same kind of tenuous logic used to conclude that forfeitures cannot be used to reduce Safe Harbor contributions and QNEC's. OK, I can see the basis for the conclusion (401© refers to 404, 404 to 414, 414 to 401a17), but that seems way too indirect to ignore commonly accepted understandings of the rules which have been consistently applied for the same 30 year period you reference, UNTIL the IRS issues formal guidance to the contrary (as they chose to do with QNEC's/forfeitures).

In fact, Line 6 of the worksheet reads "Multiply $230,000 by your plan contribution rate (not the reduced rate)" which I believe supports our position that no reduction below the max comp limit is required. Wait a miniute, if you put $650,000 on Line one of the worksheet, won't you get the outcome we are suggesting??

Please let me know how the worksheet comes up with a different result here.

Answer: You have to complete steps 3 to 5 first to find out if amount on line 5 is less than line 6.

Determine the contribution using the calculation in step 3 and 4 and enter contribution amount on step 5. Note step 4 says use rate from rate table (rt. col on P23 ),not plan contributon rate. Highest rate is 20% (.20) for plan contribution rate of 25%.

step 6 multiply 245,000 by plan contribution rate, (left column on p 23), not the reduced rate

step 7 (employer contribution for SE) is lesser of amount on step 5 or 6.

Your question reminds of what Yogi said: If you come to fork in the road, take it.

by the way 230,000 is 245,000 in 2011.

[Bill Presson]

This was fun! Stumbled across while looking for something else.