Statutory employee issue

[Guest brewbren]

I have a new client who is a sole proprietor. However, a portion of his Schedule C income is derived from compensation from an insurance company. He is covered under the insurance company's profit sharing plan and has received a contribution as a statutory employee.

The prior TPA has used total Schedule C income in determining the 404 maximum deductible contribution for the client's own profit sharing plan, and then subtracted out the contribution made to the insurance company's plan.

It seems to me that the correct way to handle this would be to eliminate all income from the insurance company from the calculation. However, I can't find any specific authority for this. Any thoughts?

[Cathy from Chicago]

My accountant used to file two Schedule C's - one (from the insurance company that also made a contribution for me) and the second Schedule C was for strictly 1099 income...on that Schedule C he would calculate the maximum SEP contribution. Since this Schedule C had a lesser income, we showed no expenses affiliated with it. Although I am not an accountant, the system always worked. In the last couple years my tax life changed so my two Schedule C's have pro-rated expenses and I make no SEP contribution due to ownership of a company. hope this helps

[David MacLennan]

Statutory employees cannot participate in their employer's pension plans based on their income since they are not common law employees but rather independent contractors under the Code. (However they are treated as employees for certain purposes. For example, income as a “statutory employee,” is not subject to income tax withholding (but is subject to FICA withholding)). There is one exception though: with respect to income as a statutory employee as a “full-time life insurance salesperson”, they can participate in the insurance company retirement and health plan under the special exception of IRC §7701(a)(20) (other types of statutory employees do not have this exception, and are allowed to establish their own plans, since they cannot participate in their company plans). Therefore, this plan must be established with earned income that is not “statutory employee” income. I agree with your conclusion on the prior administrator's work.