Partner 401K Contribution Calculation

Hi all,

I'm a little confused regarding partner 401K contribution calculations and how to report this on the Form 1065, K-1, and Form 1040.

The situation is this: I have a partner in a general partnership with $200K self-employed income and they want to make the maximum allowable contribution to the partnership 401K ($62K since they are over age 50). I use the deduction worksheet for self-employed provided on Pub 560 and lo and behold they are allowed to take the full $62K deductible contribution. I believe at this point the $62K should be reported on line 13d of schedule K (code R), $200K self-employment income should be reported on line 14a of schedule K. The schedule k-1 should show the same thing: box 13, code R will be $62K, and box 14, code A will be $200K. These amounts then go on the 1040 and the $62K deduction is reported on schedule 1.

The CPA is telling me that the amounts in excess of $25K are the partnership matching contributions and that they'll need to pay SE taxes on the excess. Is this the case? I don't see anything on Pub 560 talking about adjusting self-employment earnings, so this just threw me in a loop.

I think I explained the situation well, but let me know if I've missed out on any crucial details. Appreciate the help!

7 hours ago, George Harrison Ford said:

I don't see anything on Pub 560 talking about adjusting self-employment earnings, so this just threw me in a loop.

I'm not sure about how all of this goes on the schedules; I leave that to the accountants.  And I generally don't rely on the IRS pubs.  But yes, the first step is to reduce profits by 1/2 of SE tax.  There is in fact a footnote to Step 1 of Pub 560 which says this, although it's not a separate step:

* Reduce this amount by any amount reported on Schedule SE (Form 1040 or 1040-SR), line 1b

7 hours ago, George Harrison Ford said:

The CPA is telling me that the amounts in excess of $25K are the partnership matching contributions and that they'll need to pay SE taxes on the excess.

It may not matter but it's doubtful these are "matching" contributions.  It's a pet peeve.  Also I'm pretty sure that all of the contributions are subject to SE tax, so the CPA is wrong here.  

Also I am wondering if there are other partners (and employees?) and whether the 401k amounts have been properly elected, and whether the profit sharing (or unlikely match) is being properly allocated.  

What is your role?

Thanks for your reply, Bird!

I'm just an accountant helping prepare the partnership's tax return. I must admit that my knowledge on retirement plans is severely lacking, but I'm learning little by little everyday.

There are 2 partners in the company. Not exactly a 50/50 partnership, more like 70/30. The partnership does have employees, but they are all part-time and do not have to be included in the plan. I should also mention that the plan is a safe harbor 401K.

I think I may have phrased my question incorrectly. I should've asked if the excess amounts over $25K for the partner will be considered as additional income to that partner. I don't know if this changes your conclusion. Bottom line, I just want to know if the partner will have $200K self-employment income and they are able to take the $62K deduction for 2019. They'll have the same amount of self-employment income and pay the same amount of SE taxes regardless of whether or not they make the 401K contribution.

But let's suppose that we do the same calculation for the 30% partner and find that their maximum allowable deduction is $35K (I'm just throwing a number out there, I didn't actually run the calculations). Can the partnership make a contribution match or profit-sharing to that partner? If so, will that extra contribution be considered as additional income to the partner?

You're asking a lot of questions that are best answered by a ("the") third party administrator for the plan.  It sounds like you don't have one, which raises a red flag as to whether anything/everything is being handled properly.  I understand the "I 'just' want to know..." and have been there, but if I answer the "just" part of the question it ignores the likelihood that there are problems lurking.  e.g.:

• "The partnership does have employees, but they are all part-time and do not have to be included in the plan."  They are either in or they aren't.  "do not have to be included" is, at best, poor phrasing.  Do they/did they ever have 1000 hours in a 12 months period?
• "the plan is a safe harbor 401K."  If there are in fact no employees, then you don't need the safe harbor.  It may or may not hurt to have it, but my guess is that somebody took a document off the shelf and it is likely that each partner must get a 3% SH contribution (or a specific match).  Somehow I'm not sure about that being calc'd properly.
• Again, guessing that this plan is off-the-shelf, it is likely that each partner must get the same profit sharing contribution %.  You're asking if the partnership "can" make a profit sharing contribution for the lesser partner.  Odds are that it must, and it is linked to the what the other partner is getting as profit sharing.
• It's not clear to me when you say "401k contribution" whether you literally mean just the 401k part of the total contribution or total contribution including 401k, profit sharing and/or match.  They are all deducted on the Schedule 1 but they should be tracked separately and impact calcs differently.

I'll try to answer the basic question by explaining how we do the calcs:  We get preliminary profits from the accountant.  Sometimes this is difficult to ID so we ask "what is the number that you would pay SE taxes on, if there were no retirement plan?"  From there, we would subtract contributions for the employees, which are deducted on the partnership return (or Schedule C).  This may involve some circular calcs with subsequent steps.  Next, (ignoring some other potential adjustments) we subtract 1/2 the SE tax.  From here, we subtract the partner's (or sole proprietor's) own contributions (again, a circular calc) to get net taxable income.  If you are trying to get to $62K then this must be at least $148K (148 X .25 = 37; 37+25 = 62).  (And this isn't 100% accurate because the 25% limit is for the employer, not each employee, but let's ignore that.)  

I'm not sure what you mean by "additional income" to the partner if a profit sharing contribution is made.  Again, we would be starting with preliminary self employment income, which generally flows through to the personal return, and then deductions are taken on the Schedule 1.  Employer contributions for a partner are either taken, or not, on the Schedule 1 so it's not impacting anything done on the partnership return or the K-1 (unless somehow guaranteed payments are affected, but they shouldn't be, but I'm not an accountant so I'm not 100% sure about those forms).

I'm afraid to ask but who prepared the plan document?

I'm sorry if my post was all over the place. There is a plan administrator. They actually provided us the total maximum deduction that the partners could take on their personal return based on their self-employment income. I thought those amounts were all we needed in regards to making a contribution, so I didn't ask for any more info. As to your other remarks:

• The plan administrator took an employee census and since the employees were part-time and did not pass the 1000 hour threshold, they are not in the plan.
• So a 3% SH match must be made for both partners. Is this match considered additional income to the partners then? I'm sorry for using that word, but I don't know how else to phrase it.   

I'm afraid I'll just end up asking a ton of questions in this post, so I'll try to keep it bearable. The calculation you mentioned is exactly what shows on the deduction worksheet for self-employed on Pub 560. For the 70% interest partner, we've calculated (and were also notified by the plan admin) that the maximum deductible contribution is $62K using the 25% plan contribution rate. But what actually is this $62K amount to the partner? Is $25K considered the elective deferral and catch-up contribution, and the remaining amount profit sharing?

I won't give any names, but the plan document was prepared by the plan admin. Appreciate the help, Bird!

I was speculating a bit.  If you have an administrator, they should be telling you whether the 3% "match" is actually required for the partners; it may or may not be.  (I'm guessing it is not in fact a match; 3% would be the wrong amount, but accountants are constantly calling employer contributions matches whether they are or not.)  Also whether the profit sharing is required for both partners, in same proportion, or totally optional.  The TPA absolutely should be providing this information; if it is a large payroll or investment company then you may have a problem getting this information.  That's yours and the client's problem.

As far as "employer" contributions for partners, they come out of each partner's profits (typically).  So if your majority partner has $200K of income before contributions, and $25K is deferral (with catchup) then $37K is employer - it might be all profit sharing, or some PS and some safe harbor, and/or match.  As the accountant you don't need to care about that.  It all ($62K) comes out of his $200K and is deducted on the Schedule 1.  (As a side note, some states, or at least NJ, do not allow the deduction for the $37K employer contribution.)  I think you can see that it is not additional income.

Ditto for the minority partner; same accounting...unless, somehow and some way, the majority partner is actually paying for the minority partner's plan contributions, at least the employer part, in which case I believe there would be adjustments to guaranteed payments.  But that's a question for the accountant (you), isn't it?  (You said you are the accountant but "the CPA" is telling you things...is the CPA in your firm or some other firm?)

P.S.  I may have missed the gist of the question - generally, partners pay for their own (employer) contributions.  They could actually write a check from their own personal account, but I think typically it comes from the partnership and then how it is handled depends on whether profits have been distributed or not.  It's all flowing through as income, but that income is already included in SE income and therefore does not "add" to income.  With the caveat already noted.  All of this is really out of my area as it relates to accounting but I'm putting together different pieces that I have seen.