Self Employed to Corporation in mid-year

[Guest John Sample]

I have a client with a 401(k) plan who was self-employed from 1/1 - 3/31 and then he incorporated 4/1. He will have Schedule C income through 3/31 and wages through 12/31. If he earns over $170,000 from 4/1 - 12/31 do I have to do any self-employment calculations for the portion of the year that he was self employed? In other words can he allocate and deduct his 2000 plan year contribution under the corporation only or is it prorated between self employment income and corporate income?

I cannot find anything on this topic, but I am inclined to think that I need to prorate for the period that he was self employed.

Thank you.

[Bill Berke]

From your question it seems the sole-prop adopted a 401(k) plan. Why not have the corp adopt the same plan (it is a member of a controlled group) thus ending all the questions. If the corp is initally adopting 401(k) plan, then sole-prop can adopt and, again, all the protential issues go away. And the only thing that I remember that gets prorated is 415 number, so it seems that if you are limited to 10500, you are well under the 415 limit and can dedust on corp return.

[Guest Taxwoman]

Bill Berke,

I think, from what John Sample states, the corporation has already adopted the 401(k) plan.

To the best of my knowledge, the contributions and deductions must be prorated, i.e., they must be based on compensation paid by each entity. For example, contributions from the sole-proprietorship will be based on compensation paid by the sole proprietorship.

However, is this sole proprietor has no common-law employees, this may not even be an issue, as sole proprietors do not have to make a contribution, including a salary deferral, until their tax filing deadline .

This means that, if the client is the only employee, then he should sit with a tax advisor and determine which is more beneficial, i.e. treat the contributions as being made by the corporation or the sole proprietorship.

Another thing- why would a sole proprietor adopt a 401(k) plan? These are so complex, it does not make good business sense to adopt one unless you have a large number of common-law employees. The maximum contribution limit can be attained by adopting a paired plan ( i.e. money purchase pension and profit sharing plan combo).

If contribution limits are not an issue, and the employer wants employees to defer to the plan, then small employees should consider SIMPLE IRAs

[Guest John Sample]

Thank you for your comments. Taxwoman is correct - the employer already had a plan, so I just needed to amend the current adoption agreement form Sole Proprietor to Corporation as the Form of Business. He does have employees, who contribute into the 401(k) and he does have a paired money purchase plan.