Partner has negative K1 and a W2--combine?

[BG5150]

Company is LLC, taxed as a partnership.

A partner was issued a W2 for $150,000 from which she deferred $20,000.

The partner's K1 shows a loss.

Do I combine them for plan purposes?

[Bird]

I think you have to.

[BG5150]

Does the K1 amount get reduced further for 1/2 the SE tax and contribs to the employees?

For example, if she has +$150,000, we would be reducing that via the SE comp calculations (taxes and contribs to others).  Say it got reduced to $135,000.  I would add the $150,000 W2 to that and end up with $285k.

But if it's negative, to I further reduce it?  In the example just above, the cost of taxes and the ER contribution attributed to her was $15,000.

Say, on the K-1, the net in 14A was -$25,000.

Would her plan comp be $125,000 ($150k W2 (-) $25k loss)?  or $110,000 ($150k W2 (-) $25k loss (-) $15k taxes and contrib)?

[Bri]

Why do I remember a conference with someone saying that's likely an improperly issued W-2?

Anyway, what if you added the W-2 amount AND the underlying SE taxes associated with it back to her K-1 number.  That way you're calculating the exact SE tax she would have had deducted had all the income been run through the K-1 in the first place.  She may have overpaid her FICA in the final analysis.

[Luke Bailey]

The IRS's position is that an individual cannot be both a W-2 employee and a K-1 partner of the same partnership at the same time, so unless this was sequential (e.g., the individual became a partner mid-year), no answer is going to make sense. Was this sequential?

[Bird]

On 2/11/2022 at 8:33 PM, Luke Bailey said:

The IRS's position is that an individual cannot be both a W-2 employee and a K-1 partner of the same partnership at the same time, so unless this was sequential (e.g., the individual became a partner mid-year), no answer is going to make sense. Was this sequential?

I agree that this is improper, but it happens all the time (the lame reason that I've heard is that it makes withholding easier), and I have not heard of the IRS doing anything about it.  So we deal with it.  I agree with Bri's analysis.

[BG5150]

1 hour ago, Bird said:

I agree with Bri's analysis.

So, take 12 the SE tax off of the $150,000 amount, them combine it with the loss?

In the case above:  $150,000 (-) 1/2 SE tax (-) $25,000?

No further reduction for the partners share of the allocation to participants?

[Bird]

34 minutes ago, BG5150 said:

No further reduction for the partners share of the allocation to participants?

If the loss has not already factored in those expenses, then I'd say you have to factor them in, increasing the loss.

[Luke Bailey]

2 hours ago, Bird said:

I agree that this is improper, but it happens all the time (the lame reason that I've heard is that it makes withholding easier), and I have not heard of the IRS doing anything about it.  So we deal with it.  I agree with Bri's analysis.

I agree that this may be a decent workaround. Just pointing out that no approach is going to conform to any IRS guidance, and could be questioned in an exam.

[Peter Gulia]

Recognizing the practical reality Bird describes, some third-party administrators:

confirm that the TPA did not advise using a W-2;

inform one’s client about relevant tax law and the IRS’s view of it;

invent a method for combining W-2 and K-1 amounts in some way that approximates the correct measure of compensation for one or more retirement plan purposes;

remind one’s client that it owns the risk of whatever inaccuracy or incompleteness results from using the invented method.

[CuseFan]

Agree - do the accounting combining everything as if it was properly calculated and communicate the issue/risks as noted by Peter.

Not sure about a conference, but do specifically remember an ASPPA webcast by Darrin Watson (I watched recorded session) where he specifically said partners in a partnership getting a W2 is wrong, outside of the context of Luke's excellent sequential point.

[Nate S]

On 2/11/2022 at 9:46 AM, BG5150 said:

Company is LLC, taxed as a partnership.

A partner was issued a W2 for $150,000 from which she deferred $20,000.

The partner's K1 shows a loss.

Do I combine them for plan purposes?

Was the W-2 merely the vehicle for the guaranteed payments?  Usually see this for the purpose of making it easier for the partner to make his withholding payments & deferrals.  If so, ask the CPA to confirm that the amount, plus any other partner's similar payments were not double-counted as wage expenses before arriving at the business income, then use only the K-1 income as the earned income.  One give-away of this is that the Withdrawals and distributions in Part II Section L are $150,000.

[Bird]

18 hours ago, Nate S said:

Was the W-2 merely the vehicle for the guaranteed payments?  Usually see this for the purpose of making it easier for the partner to make his withholding payments & deferrals.  If so, ask the CPA to confirm that the amount, plus any other partner's similar payments were not double-counted as wage expenses before arriving at the business income, then use only the K-1 income as the earned income.  One give-away of this is that the Withdrawals and distributions in Part II Section L are $150,000.

I'm not sure what to make of this.  Are you saying that they might report things on a W-2 but then not include it as wages on the partnership return?  That possibility never occured to me.  I'd think that would be problematic for reconciling tax payments.

[Nate S]

1 hour ago, Bird said:

I'm not sure what to make of this.  Are you saying that they might report things on a W-2 but then not include it as wages on the partnership return?  That possibility never occured to me.  I'd think that would be problematic for reconciling tax payments.

Yes, this has become more common, especially in larger partnerships, it allows the accountant, partners, and Plan Administrator to more effectively collaborate partnership distributions, tax payments, and deferral deposits without making each event a manual process for all parties.

But if that hasn't happened here, then I think I would go back to the accountant and ask him to re-envision the K-1 as if the W-2 amount had not been paid as wages, just to ensure the wage expense and employer withholding taxes are properly accounted before performing the earned income calculation to determine the Plan's considered income.  Any other massaging of the K-1 & W-2 amounts as is, would be asking the TPA to make accounting/controller-like determinations.  Provision of the correct income amounts is a Plan Administrator function, unless the TPA is 3(16) and that's included in the service provider agreement.

[BG5150]

New twist:

Controlled Group, one a partnership and one an S-Corp.

So S-Corp issued W-2 for $150,000 and she rec'd a K-1 from the p'ship for (25,000).

Just combine the two?

[Peter Gulia]

Are the S corporation and the partnership both participating employers under the same one plan?

[Bird]

15 hours ago, BG5150 said:

Just combine the two?

Yes, assuming they are both participating employers.  Of course you have to make the usual adjustments to the self-employed income, which can be tricky but not impossible since SS taxes are not applied over the limit.

[BG5150]

yes, both are adopting employers.