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Bill, Enrolled Agent
Category: Tax
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Experience:  EA, CEBS - 34 years experience providing financial advice
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How is a defined benefit plan contribution calculated? If

Resolved Question:

How is a defined benefit plan contribution calculated? If Sch C income of $200,000 can you take a $200,000 DBP contribution deduction?
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

LEV :

Hi and welcome to Just Answer!
That is based on the type of your defined benefit plan.
For instance if you have a solo 401k plan - there are two portions - a pre-tax elective contribution and an employer's matching contribution.
A pre-tax elective contribution is limited under Code §402(g). The limit is $17,000 in 2012 plus an additional $5,500 in catch-up contributions in 2012 if you are age 50 or older at the end of the year.


Matching contributions from the employer are limited to 25% of your salary (20% of self-employment income). The compensation limitation for this purpose is $250,000 for 2012.
In addition, annual contributions to all of your accounts - this includes elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures to your accounts - may not exceed the lesser of 100% of your compensation or $50,000 for 2012.
So with $200k net self-employment income – the maximum contribution into solo 401k plan would be $17,000 (elective deferral) plus $200k*20%=$40k - but because of overall limit - the total contribution may not be more than $50k.

Customer:

Not a defined contribution plan, but a defined "benefit" plan. I'm not refering to a solo 401K either. I know on contribution/deduction can be in excess of $100K but can it be 100% of earned income?

LEV :

Sorry - defined "benefit" plan may not be used to defer tax liability for self-employed.

Customer:

It sure can. Either research further or don't charge my account please.

LEV :

The maximum annual benefit at retirement is the lesser of $200,0001 or 100% of final average pay to employees.

Customer:

That is the benefit, or the distribution from the account. How much can you contribute and deduct?

Customer:

Is it an actuarial calculation or can it be 100% of earnings?

LEV :

The issue is that the plan must satisfy annual nondiscrimination testing - if you set a plan for yourself - you may not deduct anything unless benefits are actually distributed to you.
You might not like that - but as a self-employed - you would not be able to overcome that unless you set a plan for other employees.

LEV :

$200,000 is the dollar limit is for 2012.

Customer:

There are no employees. Look up "owner-only defined benefit plans" from XXXXX XXXXX. There is a tax deduction available while still in business (minimum 3 yrs contributions).

LEV :

As I said - with the owner-only defined benefit plan - you will not satisfy annual testing and you are not an employee - and while contributions are possible - none may be deducted.
You may contact XXXXX XXXXX and verify what they meant.
I do not see how you would deduct your contribution in your correct situation… That would be too good…

Customer:

It is possible. The scenario actually involves a retiring farming. The tax planning idea is for a retired farmer with holdover grain income - let's say $750K. Sell the grain over a three year period at $250k/yr, contribute (deduct) the $250K to a defined benefit plan for 3 years. At the end of the 3 years you rollover your $750K defined benefit plan to an IRA to save the considerable admin costs associated with a pension plan. In the end you've deferred $750K of income. That's the tax planning strategy being proposed, my only question is can you truly deduct/defer the full $250K every year. I know it can potentially be more than 100K, but can it be 100% of earned income. (Not deductible on Sch C or F but deducted on form of 1040).

Expert:  Bill replied 1 year ago.

Another expert here:

You are correct that you can contribute a significant amount to a defined benefit pension and deduct it even if you are self-employed. The amount of the deduction depends on the formula in the plan if it is a traditional DB plan or the credit amount in a cash balance pension plan. The actuary would design (back into) the formula around the amount that you would like to deduct. An actuary is needed to administer the plan and perform the calculations. Depending on the number of years you have had your business and the design of the plan, you should be able to deduct a significant amount of your earned income. You could also establish a 401(k) for salary deferrals and deduct those amounts. The contributions would be deducted on line 28 of Form 1040 if you file a Schedule C.

http://definedbenefitplans.com/

http://www.roberthunterinvest.com/solo-defined-benefit-plan.htm

See pages 12, 14, 15,16 - http://www.irs.gov/pub/irs-pdf/p560.pdf

Bill, Enrolled Agent
Category: Tax
Satisfied Customers: 3078
Experience: EA, CEBS - 34 years experience providing financial advice
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