K-1 Earned Income

[Catch22PGM]

We have a new client that is a partnership.  There is one partner who also has a corporation that is an affiliated service group member that has adopted the 401(k) plan of the partnership.  Proceeds from the partnership flow through to his corporation and he receives a W-2 from that corporation along with a K-1 from the partnership.

This partner's K-1 has $500,000 in box 1, but $0 in box 14.  The CPA for the partnership is insisting that box 1 from the K-1 should be used as his earned income for plan purposes - not box 14. This partner has a small W-2 and no 401(k) withholdings listed in box 12 - both of which would be problems unless K-1 box 1 is used as his plan compensation.

I was always taught to use box 14 from the K-1 as the earned income figure (which is then reduced for 50% FICA...) to determine plan compensation. Is this correct or should box 1 of the K-1 be used as the CPA suggests? I couldn't find anything to support the CPA so I'm hoping someone here can provide clarity.

[RatherBeGolfing]

53 minutes ago, Catch22PGM said:

Proceeds from the partnership flow through to his corporation and he receives a W-2 from that corporation along with a K-1 from the partnership.

It sounds like the K-1 is issued to the partner's corporation, NOT the partner.  The K-1 is not plan comp.

This is not an uncommon setup, but its also often misunderstood.  Based on the scenario you lay out, his comp for plan purposes is his W-2 from the corporation, not the K-1 from the partnership to the corporation.   If the income passes from one entity to another (not taxed as income from self-employment), why would it count as plan comp?

[CuseFan]

Agreed. If the income does not flow through to Schedule SE (which references K1 box 14) and is not subjected to SECA taxes then it cannot be earned income from self-employment.

[fmsinc]

Get a second opinion.  

If K-1 is earned income it will be subject to withholding, FICA and Medicare and can be used to compute retirement contributions.