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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 10172
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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A follow-up question to a chat that is posted under the

Customer Question

A follow-up question to a chat that is posted under the question "LLC partnership has a 401(k) plan." I get how it should be reported, but I don't know how I can enter the retirement contribution for a partner in 13R not let it be deducted. Lacerte won't let me do that.
JA: The Accountant will know how to help. Is there anything else the Accountant should be aware of?
Customer: The wife has a retirement plan at work so they set up a solo 401(k) for the husband. I entered the total retirement contributions (elective deferral and profit-sharing) as guaranteed payments as well as Other Deductions in Schedule K Line 13 (Code R). Now book income on M-1 is reduced by both and the husband's basis is reduced for the entry in 13R (they've always had equal basis). Am I supposed to the contributions only as guaranteed payments on 1065 and K-1 (Code 13R) and not in Schedule K? My software won't let me do that.
JA: OK. Got it. I'm sending you to a secure page on JustAnswer so you can place the $5 fully-refundable deposit now. While you're filling out that form, I'll tell the Accountant about your situation and then connect you two.
Submitted: 5 months ago.
Category: Tax
Expert:  Lane replied 5 months ago.

Hi,

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For a partnership, the 401(k) contributions are NOT part of guaranteed payments.

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Contributions by the partnership on behalf of a partner must be handles in a very specific manner.

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(1) The contributions is made against "net self employment earnings," (NSEE) meaning that the NSEE is the amount that the maximum contribution is based on, and

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(2) Again, the partnership makes the contribution, you see it noted on on the K-1, and partner takes on 1040.

Expert:  Lane replied 5 months ago.

FYI, The 1065 K-1 box 13 -Code R for retirement contributions is where the contribution is listed.

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This needs, again to be figured based on the box 1 (and box 14) income.

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This is so that the partners can then take that information and show contributions for themselves on line 28 of Form 1040.

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Hope this helps

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Lane

Customer: replied 5 months ago.
Lane,Did you read Lev's response 2 years ago (chat titled "LLC partnership has 401(k) plan)? He and the customer agree that the retirement contributions for a partner need to be included in guaranteed payments. I received the same advice from a CPA who teaches a lot of CPE classes for one of the largest CPE providers. Are you aware of any regs that discuss whether or not they need to be included in guaranteed payments?Lev said that, if you don't include them in guaranteed payments, there is a risk of underpaying self-employment tax. He also says the partnership then deducts the guaranteed payments, not the retirement contributions. This was the first piece of advice that made sense to me and really clarified what the other CPA from the CPE course said. I just couldn't get it to work in the return yet because I don't know how to show the amount on K-1 Box 13R and not let it be a deduction (in addition to the guaranteed payment), so my M-1 makes sense. The other CPA from the CPE course also said that the retirement contributions should be reported on the husband's K-1 (13R) but will not affect the basis because they are reflected as guaranteed payments.After reading Lev's response, I felt that I was getting so close to nailing this down. Now I feel like I just took a couple steps back. Could you please follow up with me?Mayumi
Expert:  Lane replied 5 months ago.

That's completely incorrect.

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As long as the box 14 has the correct number, the self employment tax amount will be correct.

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THe amount that's contributed it really an out of the system, so to speak, number.

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You calculate it based on set self employment earnings, (there should be something in the partnership agreement ideally) but it's just something that the partnership is doing FOR the partner.

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The amount in k-1 is informational

Customer: replied 5 months ago.
Lane,Could you please direct me to the regs that say the retirement contributions do not need to be (or need to be) included in guaranteed payments?Mayumi
Expert:  Lane replied 5 months ago.

Let me see what I can find.

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But I can tell you both as a CRPS (Chartered Retirement Plans Specialist) and doing taxes for 6 different partnerships where I do the taxes and have theor 401(k) plas as well that this is how this is handled.

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The 401(k) administrator, for example, will typically have a form that partners' sign to accept the contribution and it's just directly from the partnership - based on Net SE earnings (I have two - who aren't always profitable - wait until after the 1065 is done to see where they're at, before making the contribution)

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Guaranteed payments can make the partnership go negative ... qualified plan contributions for partners are not ALLOWED when the partnership isn't profitable

Expert:  Lane replied 5 months ago.

When an entity contributes to its retirement plan on behalf of a self-employed individual, that individual must have self-employment earnings. 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 who only contributes capital and not services, he/she cannot participate in the partnership’s retirement plan.

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In an entity’s retirement plan, the earned income of a self-employed individual is his/her net earnings from self-employment as defined under IRC Section 1402(a). Under this section, net earnings from self-employment are the business’ gross income less allowable deductions from that income. This amount can be further adjusted by:

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  • Excluding items not includable in gross income, such as foreign earned income exempt under IRC Section 911 and deductions allocable to this income.
  • Including gains—other than capital gains—on property sales created by the individual’s personal efforts, such as an artist’s income.
  • Including earnings of certain classes of individuals exempted from self-employment tax as described above.
  • Excluding deductions to a qualified retirement plan allowed under IRC Section 404 and 50% of the self-employment tax paid under Section 164(f).

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

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Potential Issues

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Partners or LLC members treated as partnerships often defer salary contributions during a plan year based on their guaranteed payments. They then may discover after the end of the plan year, assuming the plan and partnership have the same year-end, that the partnership or LLC has a net loss. Accordingly, they do not have earned income for purposes of the retirement plan and cannot make any salary deferral contributions or receive any employer contributions. Thus, it becomes preferable for self-employed individuals to confirm they will have sufficient earned income before having contributions made on their behalf to a plan in years where they may potentially have a net loss from the partnership or the LLC. This could also apply to a sole proprietorship. Salary deferral contributions to a 401(k) plan on behalf of a self-employed individual may be made after the end of the plan year, provided that the election to defer the compensation is made prior to the end of the entity’s tax year.

Expert:  Lane replied 5 months ago.

Not the answer, but supports (in case you're using an intuit product) - I'm still looking for the IRS guidance ... aboutn 4 years ago we called IRS and got two different answers ... finally spoke to someone in their legal department ... and she made the point that including in the guaranteed payments CANNOT happen in a loss year, becasue there must be self-employment income.

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(Still looking but see this pasted below)

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"I found this response to another similar question from a TaxPro Moderator:

The 1065 K-1 box 13 -Code R for retirement contributions is where they should be listed. This is the entry point for TurboTax to calculate 401(k) contributions. If box 13 code R is blank - then the K-1 is incorrect.

Partners deduct contributions for themselves on line 28 of Form 1040, U.S. Individual Income Tax Return.

For TurboTax to deduct this on line 28 of the 1040 - you must enter the contribution amount in TurboTax using the the K-1 entry section."

Expert:  Lane replied 5 months ago.

OK here you go.

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Members of LLCs that are taxed as partnerships are treated for tax purposes as though they were partners in a partnership.

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IRC 401(c)(1) says that "employee" includes "self-employed individual," and that a self-employed individual is someone with earned income.

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IRC 401(c)(2) says that earned income is net earnings from self-employment (i.e., self-employment tax income) from a business in which the taxpayer's services are a material income-producing factor, with a number of adjustments. So, a member who is involved in the business has earned income. A member who is not involved in the business does not have earned income, whether or not he or she pays self-employment tax.

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Put those together and you find that, in general, a member of an LLC whose services are a material income-producing factor is deemed to be an employee and hence can participate in the plan.

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IRC 415(c)(3) (which is applicable to the rest of pension law through section 414(s)), says that the compensation of a self-employed individual is his or her earned income under section 401(c), with adjustments.Accordingly, payments received from the LLC are, in effect, plan compensation.

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So, yes, the contribution can come out of the individual's draw against profits, and indeed profit is the only place it can come from. (In other words, not from guaranteed payments and the member shouldn't write a personal check.)

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Guaranteed payments are paid whether there's a profit or not.

Expert:  Lane replied 5 months ago.

Please let me know if you have any questions at all.

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If this HAS helped, and you DON’T have other questions … I'd appreciate a positive rating (using the faces or stars on your screen, and then clicking “submit")

JustAnswer will not credit me for the work unless you do.

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Thank you!

Lane

I have a law degree, (Juris Doctorate), with concentration in Tax Law, Estate law & Corporate law, an MBA, with specialization in financial accounting & tax, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice, since 1986.

Customer: replied 5 months ago.
Lane,Thank you for your responses, but I'm still looking for something definitive on guaranteed payments. I'll need more time.Mayumi
Expert:  Lane replied 5 months ago.

This is what it is.

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Guaranteed payments are just that; GUARANTEED, regardless of whether the partnership is profitable ... and if the partnership is not profitable, will make the partnership loss even greater for the year.

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Contributions to qualified plans by the partnership FOR partners in NOT ALLOWED if there is no Net Self Employment Earnings. Net Self Employment Earnings IS the BASIS FOR the contribution.

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This is quite definitive.

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Treating contributions to the plan as guaranteed payments is completely erroneous and anyone telling you so i misguided.

Expert:  Lane replied 5 months ago.

From: https://www.irs.gov/publications/p560/ch02.html (I'm going to underline some things for you, and use brackets to clarify. Otherwise this is pasted directly from Pub 560)

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"Where To Deduct Contributions

Deduct the contributions you make for your common-law employees on your tax return. For example, sole proprietors deduct them on Schedule C (Form 1040) or Schedule F (Form 1040), Profit or Loss From Farming; partnerships deduct them on Form 1065, U.S. Return of Partnership Income; and corporations deduct them on Form 1120, U.S. Corporation Income Tax Return, or Form 1120S, U.S. Income Tax Return for an S Corporation.

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Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040. (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., you receive from the partnership.) [This is the reference to the box 13 code R]

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Remember that sole proprietors and partners can't deduct as a business expense contributions made to a SEP [or any other plan] for themselves, only those made for their common-law employees."

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[You will not find any reg that says NOT to include in guaranteed payments, but what you see here is the fact that (1) Guaranteed payments IS an expense - a deduction) to the partnership and (2) the contribution is deductible on1040 for the partners.

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Including in both would (along with causing the possible issues of prohinbited contributions) be taking the deduction twice (lowering the partnerships taxable income and then taking a deduction onthe 1040 as well.

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