K-1 Income Determined on Cash Basis

[austin3515]

Partner in a Partnership has SE Income of $200K before deducting his $50,000 PS contribution. CPA wants to deduct the 50K in the year funded. Does that mean that for testing purposes I get to use $200K for nondiscrimination testing (only a 25% contribution vs. a 33% contribution)?

Or let's say the Plan has a 3% Safe Harbor Contribution only. Will the owner get 3% of $200,000 instead of 3% of ($200,000 - Safe Harbor)?

In year, it might well pay to take the deduction in year 2. Is there a requirement that Earned Income be reduced for the current year contributions?

[Kevin C]

We had this come up last year and decided to reduce the earned income by the partner's employer contribution.

Section 401©(2)(A) defines earned income and includes in (v) that it is determined "with regard to the deductions allowed by section 404 to the taxpayer" . The contribution, provided it is timely deposited, is allowed to be deducted under section 404. In our case, under 404(a)(6), the employer contribution was considered under Section 404 to have been deposited on the last day of the prior tax year. Since 401©(2)(A)(v) says "allowed by" and not "deducted under", we felt that reducing earned income by the partner's employer contributions allocated for the plan year was appropriate.

[austin3515]

It's all in a word... I totally agree with you.

[John Feldt ERPA CPC QPA]

From TAG:

See Treas. Reg. 1.404(a)-1© and Don E. Williams Co. v. Commissioner, 429 U.S. 569 (1977). Contributions may be deducted for a prior taxable year if the actual contribution is made no later than the due date including extensions for the employer's federal tax return for such year. This rule applies to both cash basis and accrual basis taxpayers.

[Belgarath]

This is an interesting question, and I haven't attempted to analyze it in great detail, for the simple reason that (so far) all such clients have deducted for the prior year.

I don't think the ability to deduct for a prior year is in question, if contributed within the 404(a)(6) period - that's moving away from the original question. The question was, what compensation is used for nondiscrimination testing if the DON'T deduct for the prior year.

To take it another step, and solely for purposes of discussion to illustrate the point, suppose the client is not on extension, so the contribution must be made by 4/15 to be allowed as a deduction for 2013 under 404(a)(6). Further suppose it is a fixed formula, REQUIRING an employer contribution for 2013. The client makes the contribution on 4/30. So the client CANNOT deduct it for 2013, and it is not "allowed" under 401©(2)(A)(v) for 2013. But under 415, this contribution is made timely, and is ALLOCATED for 2013. The plan definition of compensation is "earned income" for the plan year (2013) for self-employed individuals.

Although I'm not sure the statutory/regulatory/plan language necessarily contemplates such a situation (but it very well may, in something I haven't considered!) I lean toward taking a "reasonable" approach, and to me, if the contribution is allocated for 2013, you would do the earned income reduction to arrive at the appropriate allocation and compensation for testing purposes. However, I could be convinced otherwise by someone who has looked at this in greater depth and can provide a better argument! I'll be interested to see what people think.

[austin3515]

That IS an interesting twist...