Single member LLC- taxed as sole prop- W2 or Schedule C?

[mefrancis1729]

I have a take over plan that is a single member LLC that is taxed as a sole prop. The owner pays himself W2 wages in payroll throughout the year and then also files a Schedule C reporting his net income. For plan purposes, is his compensation W2 or Schedule C or a combination of both? Everything I have found states you cannot pay yourself W2 wages when you are a Schedule C filer, however this is how the CPA is doing it.

[Lou S.]

I think he's doing it wrong but the income is sum of the two.

[Bird]

Agreed. "Everybody is doing it" because withholding is easier/better* than making quarterly payments, and the IRS does not seem to care.

*I thought it was convenience but I also believe that payroll withholding is treated as being done throughout the year, even if it is all done on a Dec 31 paycheck, whereas quarterly payments must be pro-rated.

[JAY21]

I think Bird nailed the reason right on the head. We are seeing this a lot.

[Belgarath]

So for plan contribution calculation purposes, how are you handling it? One calculation as W-2, then subtracting that from Schedule C like you would for an "employee" then doing the Schedule C earned income reduction calculation, etc., or some other method?

Or are you adding the two amounts, and doing it all as one schedule C calculation (taking into account the SS already withheld from the W-2)?

Other?

[Bird]

Mmmm, after saying we're seeing it a lot, I can't quite find an example of how we handled it. I know I have one where income was way over $265K so it didn't matter (to me, although it raises the question of where the accountant deducts the contribution).

I think you have to do it as two calcs, as in your first example.

[SoCalActuary]

We encountered this issue in the current year by having an IRS audit of the client's tax return (1040) in which they had K-1 with a big loss from their LLC, and W-2 for the same person. The net income was negative, so there was no net earned income. The business has to restate their tax returns for the audit year and following year, and corrected it in 2015 return. So, in this case, the IRS enforced their position.

[Belgarath]

Thanks SoCal. So just to make sure I understand -

1. How was the original tax return filed, and how was the retirement plan calculation done?

2. After audit, what exactly had to change?

Sounds like the IRS said, "no dice" on W-2, and said it all had to be converted to earned income, and the net was negative, so no contribution was permissible?

Thanks!

[jpod]

SoCal: As part of the audit wrap up will there be a refund of FICA taxes?

[SoCalActuary]

jpod, thanks for the suggestion.

Belgarath, you are correct. as that was the exact outcome.