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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 11145
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Myself and 8 other members of a healthcare organization have

Customer Question

myself and 8 other members of a healthcare organization have set up a k1 business plan. we have 1 w2 employee. we also have a group 401 k. how much money can each partner contribute to the 401 k and how much can be deducted monthly from the partner paycheck? right now we are only dedctucting $1500/month for the 18,000 salary deferrel but many of the partners wish to contribute more (from the Corporation match)
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

I hold a JD (Juris Doctorate, a doctoral degree in the law), with concentration in Tax Law, Estate law & Corporate law, an MBA, with specialization in finance & tax, as well as CFP® and CRPS (CHARTERED RETIREMENT PLANS SPECIALIST) designations. - I’ve been providing financial & tax advice since 1986.

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There are several issues that arise here. (THe salary deferral as you mention, but also...)

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First there is the ADP and ACP tests that limit what key employees and highly compensated employees can deduct based on what's being contributed and deferred by the non-highly compensated employee.

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Second there's the annual compensation limit: $265,000 in 2015 and 2016 (IRC Section 401(a)(17))

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Third there' the overall limit: total employee and employer contributions (including forfeitures) - the lesser of 100% of an employee’s compensation or $53,000 for 2015 and 2016 (not including "catch-up" elective deferrals of $6,000 in 2015 and 2016 for employees age 50 or older) (IRC section 415(c))

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The ADP and ACP tests are beyond the scope of this venue ... I can make an offer to run the numbers for you ... they will depend on the rules that differentiate those three groups (ownership and salary level both come into play) ...It's likely that this may be the MOST limiting factor if the disparity between the one non-owner employee's compensation and the partners is large.

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But IRS has created a surprisingly easy to understand example that show how the other limitations AND the way the plan document is written comes into play.

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See this:

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Example: Mary, age 49, whose annual compensation is $360,000 ($30,000 per month), elects to defer $1,458 per calendar month, up to $17,500 for the 2014 year. Mary may contribute to the plan until she reaches her annual deferral limit of $17,500 even though her compensation will exceed the annual limit of $260,000 in September.

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Employer matching contributions

If your plan provides for matching contributions, you must follow the plan’s match formula.

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Example: Your plan requires a match of 50% on salary deferrals that do not exceed 5% of compensation. Although Mary earned $360,000, your plan can only use up to $265,000 of her compensation when applying the matching formula for 2015. Mary’s matching contribution would be $6,625 (50% x (5% x $265,000)). Although Mary makes salary deferrals of $18,000, only $13,250 (5% of $265,000) will be matched. She must receive a matching contribution of $6,625 (50% x $13,250) under the terms of the plan.

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What does your plan say?

Although not common, a plan can specifically require that salary deferrals cease once a participant’s compensation reaches the annual limit.

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If your plan specifies that salary deferrals be based on a participant’s first $265,000 of compensation, then you must stop allowing Mary to make salary deferrals when her year-to-date compensation reaches $265,000, even though she hasn’t reached the annual $18,000 limit on salary deferrals, and must base the employer match on her actual deferrals.

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Customer: replied 1 year ago.
Thanks for the info, but the question I want answered is can the k1 corporation put I. Money for us as a salary deferred? Right now, my partners and I have the $1500 taken out every month. We save money through the year and give it back to the Corp to put into our 401 k on top of out $18k salary deferred. For ex I put in 18 k salary deferred, saved up 19k through the year and gave it back to the Corp in late December to put into my 401k. Does that make sense? My partners and I wonder if there is a way instead of saving the $ through the year and giving back instead if it can be taken out monthly like our salary deferred is?
Customer: replied 1 year ago.
Also exactly how much can each partner contribute above his/her 18k salary deferrel?
Expert:  Lane replied 1 year ago.

Can you tell me what your business entity is? You said K-1 ... this could either be an S-Corp or a partnership.

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The 1120-S (tax return for an S-Corp) generates a K-1 for shareholder employees

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But the 1065 (tax return for a partnership) also generates a K-1 for it's partners

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The answer will change depending on that

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Let me know, if you would please, and we can go from there

Customer: replied 1 year ago.
Partnership
Expert:  Lane replied 1 year ago.

OK, 401k contribution calculation for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship work like this:

  • Employee Salary Deferral Contribution: These business organizations do not provide a W-2 salary to the business owner. The employee salary deferral contribution is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax (this is termed net adjusted business profit). In 2015, 100% of net adjusted business profits income up to the maximum of $18,000 (or $24,000 if age 50 or older) can be contributed as employee salary deferrals into a 401k.
  • Employer Profit Sharing Contribution: An employer profit sharing contribution can be made up to 20% of net adjusted businesses profit. Net adjusted business profit is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax

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Bit again, you have to treat the partners as self-employed individuals for this purpose and then the employee as an employee, using SALARY as the basis.

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To have the entity make a contribution to the entity’s retirement plan on behalf of the self-employed individual, the individual must have earnings from self-employment.

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Under IRC section 401(c)(2), the individual’s earnings from self-employment must be from a trade or business in which the individual’s services are a material income-producing factor. (For example, if the individual is a partner that only contributed capital and does not provide services to the partnership, he cannot participate in the partnership’s retirement plan).

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For partners in a partnership (other than limited partners), net earnings from self-employment include the individual’s distributive share of partnership income or loss (other than separately computed items such as capital gains and losses) and any guaranteed payments received from the partnership.

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It's generally preferable for self-employed individuals to wait until it is clear that they will have sufficient earned income before having any contributions made on their behalf to a plan in years where they may potentially have a net loss from the partnership or the LLC.

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The three big issues I see in reporting earned income for retirement plan purposes to your TPA administrator include the following:

  1. Failing to net guaranteed payments with the partner’s or LLC member’s share of the distributive income or loss.
  2. Failing to report the net income from all related entities that participate in the retirement plan. This occurs, for example, when there is a structure of related LLCs for tax purposes and the members receive income or losses from more than one of the entities and these amounts are not netted for purposes of determining earned income for purposes of their retirement plan.
  3. Failing to have related self-employed businesses adopt the retirement plan so that earned income from all businesses is considered for the plan.

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So to COMPLETELY answer your question I'd have to look at your plan document to see if you've allowed for profit sharing and/or matching ... but as you can see the answer for each partner COULD be different

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Generally, however it's those first two bullet points above

Expert:  Lane replied 1 year ago.

If you like I can make an additional services offer so that we can discuss this over the phone

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Qualified pans for self-employeds (partners, members, sole proprietors) gets a LITTLE complicated.

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Qualified plan design, implementation, analysis, and administration is what I do.

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Only accept the offer if you'd like my help.

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Otherwise, if this HAS helped, I'd really appreciate your positive rating … (by using the stars or rating request on your screen) … … That’s the only way JustAnswer will credit me for the work.

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Thank you,

Lane

Expert:  Lane replied 1 year ago.

OK, I've made the offer (you should see something to accept, if you'd like to discuss)

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I made it for the smallest amount JA allows ($5)