401K Plan Contribution Calculation for the Self-Employed with Employees

401K Plan Contribution Calculation for the Self-Employed with Employees

So how much can the self employed person contribute to a 401K plan with employees for elective, non elective (safe harbor), and profit sharing?

1. As an “employee” the self employed can contribute up to 18,000 for 2017 + an additional 6,000 if 50 or older. Of course there has to be “earned income” from the self employment.

2. What if the self employed person has employees? The plan is going to required a certain level of participation for the 401K plan to be a qualified plan. Often the employees are not interested in setting aside part of their paycheck for retirement. They need all of their pay check for rent and groceries.

So the company in order for the plan to qualify has to set aside some % of the employees salary. So for example 4% of compensation is used.

And in this example the regular employees’ wages is 100,000. So 4,000 would be contributed to the employees’ 401K plan on their behalf.

Well what about the self employed person. Let’s say the net profit from schedule C is $90,000 in 2017. And the self employed person is 54 years old.

Can we set aside 4% for the self employed person? Yes but there is a calculation. The 4% is applied after the 4% is taken into consideration. Yes, it is confusing.  Let’s take a look at the 401K plan contribution calculation.

 

The 401K plan contribution calculation: an example

Net Profit Schedule C                                    90,000

Less deductible portion on SE tax           (6,358)
Line 27 of the 1040                                        ——

83,642
=======

4%/104% = .038462 X 83,642 = 3,217

3. So the third question is what if the business had a great year and the self employed person would like to make an elective contribution (a profit sharing)?

Yes that can be done. So for example the owner decides to make a 8% contribution to the regular employees’s 401K plan  in addition to the 4% safe harbor (non elective) contribution.

Can the owner also participate in the profit sharing and make a contribution to his 401K plan? Yes!

8%/108% = 7.41% is the equation for the percentage. The owners profit sharing amount would be 83,642 X .0741 = 6,198.

So in total the owner can contribute 18,000 + 6,000 + 3,217 + 6,198 = 33,415.

Please keep in mind there is a top limits that can be contributed. 54,000 + 6,000 for the over the age of 50 catch up.

Make sure to see your tax advisor regarding your particular situation.

Form 8962 and Married Filing Separately

Form 8962 when filing Married Filing Separately (MFS)

If your health insurance was obtained through the government exchange and you estimated your household income was between 100% and 400% of the federal poverty line, then you got help in paying your insurance premium from the government. The Advance Payment of the Premium Tax Credit (APPTC) went right to the insurance company and you never saw that money, but you did get the benefit.

So now at the end of the year comes the time of settling up. For example if you said your were earning $XX dollars and the government advanced the health premiums based on that situation, and then it turns out your made $XXX + for the year, the IRS want some of the money back. Of course if you made more that the 400%, then the IRS wants all of it back. Or it can work the other way, if when you signed up for the Exchange you said $XXX was going to earned and you earned less, then the IRS is going to give you a credit.

You will be getting a 1095-A from the IRS. And in column C is the APPTC. This is the money the government sent to the insurance company to help pay your premium.

This is good except what happens if you decided to file a MFS tax return.

You don’t get the Premium Credit if you file MFS,  unless you meet the following exception.

1. You can file MFS if you were a victim of domestic abuse or

2.  your spouse abandoned you.
What happens when you were planing on filing Jointly and then events happen.

So let’s take an example.

When your family applied for the credit you were intending to file Married filing Jointly, but maybe circumstances change and your spouse wants a divorce, then one of the spouses may be able to filed Head of Household (HOH) living apart or Single living apart. The spouse filing HOH or Single is eligible for the premium tax credit.

So for example, maybe one spouse moved out of the house and took the child, and now qualifies for HOH. Then the remaining spouse is in the MFS category and barred from the Premium Tax Credit.

Let’s take another example. The family is living together, but the husband is a general contractor and his wife is concerned about the tax position taken on his Schedule C Sole Proprietorship. The wife does not want to be involved with a Joint tax return because of questionable deductions.

At then end of the year the 1095-A arrives, and it has your social security number and lists the covered individuals as you and your spouse and the 2 children. And in our example your spouse took both children as dependents.

You are filing MFS and are looking at the form 8962. You know you are not entitled to any credit and will have to repay your portion of the credit.

But how much and how to fill out the form?

You have to mark under Part II line 9 the YES box.

Next go to Part IV and the SS of the OTHER taxpayer – yes your spouse.

Now how much to included?
Going back to the instructions for Line 9, it talks about Your tax family and a Second tax family (your spouse and the 2 kids). In our example, we meet both conditions and so we would go to TABLE 3 of the instructions and follow the Allocation of Policy Amount.
TABLE 3 has 3 options

A. Divorced or legally separated.

B. Married at the end of the year and filing MFS

C. No Advanced payment was paid for the policy.

So our taxpayer is B.

Now we have to go to Allocation Situation 2.

If you find the Allocation Situation 2 it says 50% is to be reported on Part IV.
Then if you look at page 5 of the instructions, it tells you have to report 50% of the Advanced Premium Credit which confirms what the Allocation Situation 2 says also.

Then go part IV and put down 50%.

This is counter to what you might conclude that the husband filing MFS would report 25% and the wife with the 2 children would report 75%.

So for our example if the Advance Payment of Premium Credit reported on 1095-A- line 32 column C was 10,000, our MFS taxpayer would have to report 5,000 on line 46 of  the general contractor’s 1040.

Expensed vs. Capitalized

Repair vs. Capitalized

The question is what items can be expensed vs. capitalized?

The provisions are as follows.

1. De Minimis safe harbor. $2,500 per invoice or item (as substantiated by the invoice). If you have an audit done, then $5,000.

If the taxpayer arranges with the contractor to take the cost of a $10,000 new bathroom and have the contractor break it up into 4 invoices, does that qualify?

The IRS thought about that one.

26 CFR 1.263(a)-1(f)(6)Anti-abuse rule. If a taxpayer acts to manipulate transactions with the intent to achieve a tax benefit or to avoid the application of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, appropriate adjustments will be made to carry out the purposes of this section. For example, a taxpayer is deemed to act to manipulate transactions with an intent to avoid the purposes and requirements of this section if –

(i) The taxpayer applies the de minimis safe harbor to amounts substantiated with invoices created to componentize property that is generally acquired or produced by the taxpayer (or other taxpayers in the same or similar trade or business) as a single unit of tangible property; and

(ii) This property, if treated as a single unit, would exceed any of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, as applicable.

The Regulation at 26 CFR 1.263(a)-1(f)(7) gives various examples.

Let’s take an example. You buy a computer worth 2,600 and with that you buy a printer that costs $400, 2 items on one invoice. The printer qualifies, but not the computer.

A. A written accounting procedures that the firm is going to write off as an expense items of $5,000, but written procedures not required for the $2,500 limit.

B. The election must be made each year.

C. Even if you do not qualify for the election, that does not automatically mean you have to capitalize.

Let take a look at that example above where the computer costs $2,600. And change the facts so that the computer is sent to the local shop for work. Is the $2,600 of work a repair or an improvement.

It could be that the $2,600 was spent to replace a computer board that was defective and qualifies as a repair. So regardless of the the de minimis safe harbor rules the $2,600 would be deductible.

Before you address the various safe harbors you have the question is this item a Unit of Property “UOP”? Is the printer in our example above a unit of property? Is the printer dependent on another piece of property (for example the computer)? If the printer is dependent on the computer, then it does not qualify for the De Minimus safe harbor even though it cost under $2,500.

(e)Determining the unit of property – UOP

(1)In general. The unit of property rules in this paragraph (e) apply only for purposes of section 263(a) and §§ 1.263(a)-1, 1.263(a)-2, 1.263(a)-3, and 1.162-3. Unless otherwise specified, the unit of property determination is based upon the functional interdependence standard provided in paragraph (e)(3)(i) of this section.

(3)Property other than building –

(i)In general. Except as otherwise provided in paragraphs (e)(3), (e)(4), (e)(5), and (f)(1) of this section, in the case of real or personal property other than property described in paragraph (e)(2) of this section, all the components that are functionally interdependent comprise a single unit of property. Components of property are functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer.

Special rules. However, special rules are provided for buildings (see paragraph (e)(2) of this section), plant property (see paragraph (e)(3)(ii) of this section), network assets (see paragraph (e)(3)(iii) of this section), leased property (see paragraph (e)(2)(v) of this section for leased buildings and paragraph (e)(3)(iv) of this section for leased property other than buildings), and improvements to property (see paragraph (e)(4) of this section). Additional rules are provided if a taxpayer has assigned different MACRS classes or depreciation methods to components of property or subsequently changes the class or depreciation method of a component or other item of property (see paragraph (e)(5) of this section). Property that is aggregated or subject to a general asset account election or accounted for in a multiple asset account (that is, pooled) may not be treated as a single unit of property.

Lets take a look at Buildings:

The building is in 2 parts: the Building System and the Building Structure.

A. Building Structure
B. Structural components/Building system: plumbing, electrical, HVAC, elevators, security systems, natural gas, and other components.
So once you have defined the UOP; Was the expenditure a repair or cap expenditure.

FACTS and CIRCUMSTANCES

What is a capital expenditure?

1. Betterment – amount paid to fix a material condition or material defect, material addition or materially increase productivity.
Of course what does “material” mean.

2. Restoration – replace a major component or a substantial structural part. Then of course you have to write of the cost of the component replaced. So for example a new roof. If I capitalize a new roof, then I should write off the adjusted basis of the old roof.

So now the question is what is the cost of the old roof. You will need either a cost segregation study or a IRS accepted method to determine the adjusted basis.

3. Adaption to a new or different use.

2. Small taxpayer safe harbor for OWNED or LEASED building

So lets say the cost meets the definition of a building improvement. How does this safe harbor work?

1. Taxpayer must have gross receipts less than 10,000,000.

2. Cost of building (excluded land) is less than 1,000,000.

3. Total cost of repairs and improvements do not exceed:

The LESSER of 10,000 or 2% of the original basis of the building. So even if it is an improvement, you can expense the lessor of 2% or 10,000.

3. Safe Harbor for Routine Maintenance

Even if the item is an improvement, you do not need to capitalize if:

Recurring activity

To keep property in the ordinary operating condition

You expect to preform this activity

A. Every 10 years for a Building. A new roof would last longer than 10 years so this would not be routine maintenance.

B. For non building more than once during its tax life.

For example, if you had a copier and had the repair man come out and clean, and he had to replace a part that cost $3,000. Even though the De Minimis safe harbor, and the small tax payer do not apply, the Routine Maintenance safe harbor would.

Safe Harbor for Routine Maintenance does not apply to improvements that are Betterments.
4. Facts and Circumstances – If the improvement does not qualify under the 2,500 exclusion De Minimus, nor the Small Taxpayer exclusion nor the Routine Maintenance, then look at the Facts And Circumstances.

Repair vs. Capitalized

What is a capital expenditure?

1. Betterment – amount paid to fix a material condition or material defect, material addition or materially increase productivity.

2. Restoration – replace a major component or a substantial structural part.
3. Adaption to a new or different use.

Even if you elect one of these simplfying provision it is possible that the safe harbor does not protect the entire cost.
4. IF YOU DON’T WANT TO GO THRU THIS ANALYSIS

You can elect to capitalize repair and maintenance as improvements.

Why you would want to do this, I am not sure. Possibly if you are not able to currently take the benefit of deducting the repairs and maintenance.

And the election has to be done each year.

5. Rehabilitation Plan.

Even if the cost is a repair, it may still end up being capitalized because it was part of an overall plan.

Say for example you buy a house and are going to rent it out. You decide to paint the home, patch the roof, clean the front walkway. Each of these item is a repair, but because it is part of a plan to Rehabilitate the house, then you have to capitalize. Does it matter that each of the items is separately invoiced? It certainly helps to make the case that the repairs were not part of an over Plan, but not if the overall Plan was decided before the start of the first repairs and the taxpayer is being billed as the work is completed.

How this is a better place than before the new IRS regs is hard to accept. This is a general discussion.

See you tax preparer for your particular situation  about whether a payment is a repair vs. capitalized item.