Employee Plans News - October 8, 2010 - We're Glad You Asked!
I am self-employed and have a profit-sharing plan for my employees and myself. For 2009, I decided to make a plan contribution equal to 10% of each participant’s compensation. To determine the amount allocated to my own account, I multiplied my net profit on my Schedule C by 10%. Was this correct?
No. You made two errors: (1) you used the net profit from your business to base your percentage on; and (2) you did not reduce the plan’s contribution rate that you used for yourself.
For a self-employed individual, “compensation” means “earned income.” You must use your earned income to calculate plan contributions for yourself. Your earned income is not the same as net profit from your business. You calculate your earned income by taking your net profit from Schedule C and subtracting:
1. ½ of your self-employment (SE) tax; and
2. plan contributions for yourself.
Your earned income and the amount of your plan contributions for yourself depend on each other. You must reduce the plan contribution rate to calculate the correct amount of plan contributions for yourself. See Publication 560, Retirement Plans for Small Business, to find the correct rate and the worksheet to calculate your deduction.
Example:
Joe’s 2009 Schedule C net profit is $200,000 and he paid $18,600 in SE taxes. The plan contribution rate is 10% of each participant’s compensation. Joe would compute the amount of the 2009 plan contribution for himself as follows:
|
1. Net profit from Schedule C: |
$200,000 |
|
|
2. Less ½ of SE tax: |
(9,300) |
|
|
3. Joe’s net profit less ½ SE tax is: |
$190,700 |
|
|
4. Joe’s reduced plan contribution rate |
x 0.090909 |
|
|
|
$17,336.35 |
|
The limit on annual compensation (adjusted annually) for determining retirement plan contributions was $245,000 in 2009. Joe’s 2009 earned income (compensation) was less than the 2009 annual limit and, therefore, he does not have to restrict contributions for himself.
Plan contributions for a self-employed individual are deducted on Form 1040 (on the line for self-employed SEP, SIMPLE, and qualified plans) and not on the Schedule C. If you made the deduction on Schedule C, or made and deducted more than your allowed plan contribution for yourself, you must amend your Form 1040 tax return and Schedule C.
If your plan contribution for yourself was higher than allowed by the terms of your plan, you may have a plan qualification issue. However, you may fix this plan error by using the Employee Plans Compliance Resolution System.
