Plan Establishment and “Compensation”
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor from Georgia is representative of a common inquiry related to setting up and contributing to qualified retirement plans. “My client is a shareholder in an S-Corporation. Can the business still set up a retirement plan for 2022 and can she contribute to the plan based on her S-Corporation distributions?”
Highlights of the Discussion
Because this question deals with specific tax information, business owners and taxpayers should always seek the guidance of a tax professional for advice on their specific situations. What follows is general information based on IRS guidance and does not represent tax or legal advice, and is for informational purposes only.
With respect to setting up a plan for 2022, the short answer is, yes, provided the S-Corporation has an extension to file its 2022 tax return. Regarding contributions for your client, she could not base plan contributions on her S-Corporation distributions for 2022. She could only receive a contribution if she also had wages as an employee, which were reported on Form W-2, Wage and Tax Statement. (Please refer to Retirement Plan FAQs Regarding Contributions - S Corporation.)
Now for a bit of background. Under the SECURE Act 1.0, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline as illustrated below. [Note: Simplified employee pension (SEP) plans have historically followed the below schedule; and special set-up rules apply for safe harbor 401(k) plans.]
Business Tax Status | IRS Business Tax Filing Form | Filing Deadline (and deadline to establish a retirement plan unless an extension to file applies) | Extended Filing Deadline (and latest deadline to establish a retirement plan) | Starting Point for Compensation or Earned Income for Plan Contributions |
S-Corporation (or LLC taxed as S-Corp) | March 15 | September 15 | ||
Partnership (or LLC taxed as a partnership) | March 15 | September 15 | Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc. * See below for adjustments** | |
C-Corporation (or LLC taxed as C-Corp) | April 15 | October 15 | ||
Sole Proprietorship (or LLC taxed as sole prop) | Form 1040, U.S. Individual Income Tax Return with Schedule C | April 15 | October 15 | Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship) Schedule F (Form 1040), Profit or Loss From Farming See below for adjustments** |
*Not to be confused with Schedule K-1 for Forms 1120s or 1041
**The definition of compensation for contribution purposes for unincorporated business owners (i.e., sole proprietors or partners) is unique [IRC 401(c)(2)(A)]. It takes into consideration earned income or net profits from the business [reported on Schedule C (Form 1040), Schedule F (Form 1040) or Schedule K-1 (Form 1065)], which then must be adjusted for self-employment taxes. The result is the individual’s “adjusted net business income (ANBI).” A retirement plan uses ANBI to allocate plan contributions. Please see the worksheets for self-employed individuals in IRS Publication 560, Retirement Plans for Small Businesses.
And here’s something owner-only businesses can look forward to because of the SECURE Act 2.0 of 2022 (SECURE 2.0). Effective for plan years beginning after December 29, 2022, Section 317 of SECURE 2.0 allows sole proprietors or single member LLCs to make retroactive first year elective deferrals up to the date of the employee’s tax return filing date for the initial year. Currently, this is an issue as explained in a prior Case of the Week Establishing a Solo 401(k) Plan.
Conclusion
Pass-through businesses, including sole proprietorships, partnerships, limited liability companies and S-corporations have several special considerations with respect to setting up and contributing to retirement plans. Tax advisors and other financial professionals with expertise in this area can really add value and set themselves apart from the competition.