Earned Income

[nancy]

We have a client where the CPA has converted all the earned income reported on the Schedule C to capital gains and he therefore has no earned income. Does this prevent him from receiving a year of participation for 415 purposes?

[Belgarath]

As I understand it, a year of participation for these purposes is not dependent upon compensation. A year of participation requires at least the minumum hours of service, and the participant is included as a plan participant under the eligibility provisions for at least one day of the year. I suspect you satisfy both requirements. Check 1.415(b)-1(g)(1)(ii)(A).

[Andy the Actuary]

From 415 final regulations:

"(ii) Years of participation. The following rules apply for purposes of determining a participant’s years of participation for purposes of this paragraph (g)(1)—

(A) A participant is credited with a year of participation (computed to fractional parts of a year) for each accrual computation period for which the participant is credited with at least the number of hours of service (or period of service if the elapsed time method is used for benefit accrual purposes) required under the terms of the plan in order to accrue a benefit for the accrual computation period, and the participant is included as a plan participant under the eligibility provisions of the plan for at least one day of the accrual computation period."

So, did participant earn service to accrue a benefit? The key is "hour of service" (whether or not elapsed time being used) which is typically, "Each hour for which an Employee is paid, or entitled to payment, for the performance of duties for the Company." The operative words here are "or entitled to pay."

The DOA ("dumb old actuary" and not "dead on arrival") opinion is "yes, credit year of participation for 415 purposes." So, even though no pay received, participant was entitled to receive pay. Check out your plan language and then obtain a legal opinion, which is how I would proceed if faced with your question.

[ubermax]

the answers above are great ; my question & curiosity is how the CPA converts earned income to capital gains ? - I thought gains were related to asset investment - I'll admit that I've been away from sole props & partnerships for awhile but from the little that I recall I thought "earned income" was a derived amount given income & expenses from the C & considering SE tax and pension contribution.

[John Feldt ERPA CPC QPA]

Also, but probably not your concern, you may want to mention to your client that it's assumed the CPA has advised them regarding reasonable compensation. There are many tax cases out there where the IRS comes in and declares certain amounts really are wages. Since that could, in turn, affect the plan, it might be worth mentioning.