Sole proprietor - Defined Benefit Plan

I am a CPA preparing tax returns.   The client has a Schedule C with $475,000 net income.  He is contributing $55,000 to a 401K and almost all of his QBID is phased out.   He also has $140,000 pension income plus some investment income.   Charitable contributions are approximately $75,000.   MFJ, 69 years old.

I would like for him to adopt a DB pension plan and defer a large portion of his net profits.   My questions are as follows:

1.  Should he elect c-corp tax status?   If so, does he need to pay himself a salary?   I am thinking of a $200,000 DB contribution and a $200,000 salary, leaving some cash in the c-corp to be taken as dividends in later years (once fully retired).   Is there a minimum salary that he must pay himself?

2.  If c-corp status is not elected, can he still set up a DB plan for himself even though he is not an employee?   Does he pay SE tax on profits before the contribution, or on profits net of the contribution?

3.  He has not yet filed his 2023 returns.  Is it too late to set up and fund a DB plan for 2023?

I would appreciate any feedback on this.   New territory for me.

Regards,

Brad

1) no, he can continue with Schedule C 2) yes, he can, he will pay SE tax on all income BEFORE the pension deductions 3) No, it is not too late to set it up retro for 2023 assuming his tax return extension has been filed timely.

Thanks so much.   I appreciate it very much.

If he's already contributed $55,000 to the DC plan for 2023, you are going to have problems deducting a $140,000 contribution to a DB plan unless there are employees that would make this a PBGC plan due to the combined plan deduction limit. If he hasn't made any 2023 contribution and is on extension, limit the DC contribution (not including 401(k), if any) to 6% of pensionable pay.

If you are setting up for 2024, talk to the plan actuary before making any contributions to either plan to make sure you don't get into nondeductible contribution issues.

As Lou alluded, he has a combined plan deduction limit on his "employer" (non-401)k) deferrals) of 31% of eligible pay - which is his net adjusted SE earnings minus those "employer" contributions limited to $330,000. This does not apply if the employer contribution to the DC plan does not exceed 6% of limited eligible pay, or $19,800 on $330,000. If $30,000 was his salary deferral and catchup, then the remaining $25,000 was profit sharing and exceeds that 6% mark. Therefore, 31% on $330,000 is a $102,300 maximum 2023 combined plan deduction.

Also as Lou stated, need to bring in an actuary, and sooner rather than later, someone who can map everything out and ensure compliance. This usually requires that any DC plan contributions other than 401(k) salary deferrals are determined last to ensure such profit sharing does not exceed 6% of eligible pay after all adjustments and deductions.

2023 is still possible but much more limited on the deduction ($77,300) than desired. He could accrue a larger benefit for 2023, just deduct the entire required contribution for 2023, carrying forward the excess for a 2024 deduction - but a knowledgeable actuary/actuarial firm should be consulted to map that out for your client. And 9/15/2024 is a drop dead date for funding 2023 and a lot of steps need to be completed before then so the process should be started early enough before then - like before Labor Day if not mid-August.

1 hour ago, Brad Jacobs said:

Should he elect c-corp tax status?   If so, does he need to pay himself a salary?

No, but if he is incorporated then only W2 compensation can be considered. Unless there is some other compelling reason, I see no advantage in being a C-corp with only the potential disadvantage of double taxation. Almost always see individuals incorporate as S-corps (or LLC taxed as an S). In that case, again only W2 pay counts as pensionable, but any K1 dividend distributions left after reasonable W2 pay and pension deductions are not earned income for Medicare taxes (assuming W2 above FICA wage base).

And all my numbers above assume owner-only plans, no employees, and "plan compensation" of at least the $330,000 maximum after all deductions.

the OP says "contributing".  If the ER portion of DC has not been contributed yet, then there is a lot of flexibity.  If it has been contributed in 2024 then there is flexibility too.  Even if the dedcution for 2023 become limuted to 31% It is definitely worth it to do a retro plan from 415 perspective.  It is time to get an actuary engaged.

Thanks to Lou and Kenneth.   This is very helpful.

48 minutes ago, truphao said:

It is definitely worth it to do a retro plan from 415 perspective.  It is time to get an actuary engaged.

Agree. Especially at that age, get the 415 years of participation clock started.