Solo 401K & Health Insurance Deduction Limitations

[TNT]

I  am trying to understand the contribution limits to a solo 401K plan and the interaction with deduction limits for self- employed (SE) health insurance. Per IRS instructions health insurance deduction is limited to net schedule C income less 1/2 SE tax,  less retirement plan contribution. link https://taxmap.irs.gov/taxmap/instr/i1040gi-010.htm#w24811v09 The main issue is if the retirement plan contribution is too high you lose/reduce the health insurance deduction, which I want to avoid.  Here is my example and understanding:

Net Schedule C profit $20,000,     Health Insurance premium $8,108,    1/2 SE tax $1,413

Maximum total contribution to solo 401K without loss of insurance deduction is $10,479 ( 20,000 -1,413 -8,108 = 14,479) and contribution to 401K plan is made up of either $10,479 employee contribution or $6,762 employee contributions plus 20% employer  contribution  of $3,717 (20,000 - 1,413 = 18,587 x 20% = 3,717)

Is my understanding & computations correct?

What about the over age 50 catch up contribution of $6,000? Not sure if this is permitted in excess of above contribution without limitations. (so total contribution to solo 401K of $16,479 ---- 10,479 +6,000)

Thanks,

T

 

[spiritrider]

Some issues to consider:

1. Is the net self-employment earnings the only earned income or is the individual's W-2(s) (Box 1 Wages + (0.9235 * business profit)) is > the Social Security maximum wage base (2017 = $127,400). If it is the latter your SE tax calculation is incorrect. For purposes of discussion let's assume the former.
2. You are missing an important point about the self employed health insurance deduction.  In this case the allowed deduction is Form 1040 Line 12 Business income - (Line 27 Deductible part of self-employment tax + Line 28 Self-employed SEP, SIMPLE, and qualified plans). The important point is that Line 28 is deductible contributions. These are 401k traditional employee deferrals and employer contributions. 401k Roth employee deferrals are not included in Line 28.
3. With $18,587 in net self-employment earnings an individual could make:
   1. $18,000 Roth employee deferral*
   2. $6,000 Roth catch-up contribution*, **
   3. $294 employer contribution***
   4. $8,108 self employed health insurance deduction
   5. $6,500 IRA contribution.
   6. $38,902 Total

* Roth contributions do not reduce the amount available for either the self employed health insurance deduction or compensation available for IRA contributions.

** Catch-up contributions are not included in annual addition limits including the 100% or compensation limit.

***The employer contribution is limited to (net self-employment earnings -  any employee deferrals) / 2.

[Jackson W]

@spiritrider Where would you go in the IRS text to justify that you can do a Roth contribution on the same dollar that is used for a Roth deferral and SEHI deduction? Would love to understand this better. 

[spiritrider]

On 5/28/2020 at 2:05 PM, Jackson W said:

@spiritrider Where would you go in the IRS text to justify that you can do a Roth contribution on the same dollar that is used for a Roth deferral and SEHI deduction? Would love to understand this better. 

You realize you are resurrecting a > two year old zombie thread.

For the Roth 401k contribution and Roth IRA contribution, see IRS publication 590-A, What Is Compensation?, page 6:

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

• The deduction for contributions made on your behalf to retirement plans, and
• The deduction allowed for the deductible part of your self-employment taxes.

A Roth 401k contribution is not a deductible contribution and therefore does not reduce compensation. For W-2 employees, Roth 401k contributions do not reduce W-2 Box 1 wages (compensation).

For the SEHI deduction the Roth 401k contribution, see Form 1040, Self-Employed Health Insurance Deduction Worksheet—Schedule 1, Line 16, page 86, Line 2.

Enter your net profit* and any other earned income** from the business under which the insurance plan is established, minus any deductions on Schedule 1, lines 14 (1/2 SE tax) and 15 (401k deduction). (labels mine)

The SEHI deduction does not reduce compensation available for IRA contributions and the Roth 401k contribution does not reduce self-employed earned income available for the SEHI deduction, because it is not a deductible contribution.

P.S. There is an error in my previous post from two years ago. The employee deferral + catch-up contribution can not exceed net self-employment earnings. So item 2. can be only $587 and if so, item 3 will be $0.