Sole Prop defers on draw, then has zero Sch. C income

Florida Swampland Realtors is a sole proprietorship, no common-law employees. The owner and sole employee, I. M. Cheating, defers maximum based on a salary draw for 2020. After end of year, taxes get done, and it turns out he has zero earned income - actually a big loss. So there's a 415 excess, plus earnings,  to be refunded. Refunded in February of 2021. 1099-R is issued with the amount being shown as taxable, right? In other words, no way to use a special code to report this as non-taxable? A CPA is questioning this, and I want to make sure I'm not cracked. Thanks. 

So the CPA wants to actually have the money not taxed ever? Sweet deal if you can get it.

Well, that's what the CPA would like, and to a certain extent, I understand where he is coming from. Let's say he defers maximum in 2020 based upon the draw, but it turns out there is really a $250,000 loss. If this amount had not been deferred, his loss would still be such that he has zero taxable income. So in a way, this is turning non-taxable funds into taxable income. Sort of a doubly whammy in a way. I'm just not aware of any applicable special reporting code for the 1099-R that states that the distribution is non-taxable, but I want to be sure I'm not missing something.

We just had a discussion here.

The conclusion, or at least my conclusion, was that you report it as an excess deferral (not 415 excess which ties your hands to taxation in the year received I think), taxable in 2020.  As wrong as it might sound to us, the accountant takes a deduction in 2020 against the negative income, which washes out the taxable income.

Thanks, but I'm forced to disagree, if by "excess deferral" you mean a violation of the 402(g) limit? That limit is a dollar limit, and that dollar limit hasn't been violated here. It isn't an ADP failure, so I don't see any option other than to consider it a 415 violation. Perhaps I'm misunderstanding what you are saying?

I though the 402(g) limit was the lesser of 100% of compensation or the hard dollar limit.  100% of zero is zero, thus the violation of the 402(g) limit.

I think you are "combining" part of 415 and 402(g)? I don't see any "lesser of" provision in 402(g).

The catchup limit definition in 414(v) has a reference to the "lesser of", such as to keep the maximum at the corresponding earnings amount,, but actual 402(g) doesn't appear to.

So did  they violate 402(g) or 415?  I have a client who did the same thing.  

Why can't you view the individual as having two tax aspects for this purpose, employer and participant. Because he had zero 415 comp, the amount cannot be allocated to his account. So it stays in plan and gets carried over to next year.

Isn't then subject to non deductible contribution penalty? This is not a minimum required contribution. just curious.

20 minutes ago, Jakyasar said:

Isn't then subject to non deductible contribution penalty? This is not a minimum required contribution. just curious.

Yes.

18 hours ago, Belgarath said:

Thanks, but I'm forced to disagree, if by "excess deferral" you mean a violation of the 402(g) limit? That limit is a dollar limit, and that dollar limit hasn't been violated here. It isn't an ADP failure, so I don't see any option other than to consider it a 415 violation. Perhaps I'm misunderstanding what you are saying?

I think you are right.  I'm not sure it would stop me from doing it as a refund of excess deferral though, as a practical solution.  Unless someone can come up with other reporting that makes sense.