Partnership income and retirement plans

[gowithmygut]

Congratulations on making it through another filing season. I have always done my own taxes using TT and thought I was doing OK. However, I an idea just hit me. I'm 50+ and trying to save as much for retirement as possible. I am employed and contributed 19K to our 401K. I also am a participant in a business partnership (10%) that reports on a K-1. There are 8 partners, there are different basis earing on my share were approx 50K before approx 25K in depreciation. My question is can a partnership set up a retirement plan? The other possibility is since I have to report the income as self employment income can I set up a tax deferal retirement account? As a comment about your ongoing TT discussion, I use TT for the ease of input I don't expect it to make good decisions for me. Making the good decisions is my responsibility. Thanks

[JoshinNC]

yes and yes

A partnership can set up a retirement plan, and you could also set up an individual plan based on your self employment earnings. You just have to make sure that you don't exceed the maximum deferral amounts for the year.

What state are you in? I am licensed to set up plans in NC only, but have associates throughout the country who could assist you if you need help.

Also, thank you for acknowledging that TT is data entry software, not tax planning software. As you will here on this board over and over, "Software is no replacement for knowledge".

[gowithmygut]

I'm in California. I assume I could have done the individual plan option prior to filing '05 taxes. Any method of still setting one up for last year and amending the already filed return?

[JoshinNC]

not unless an extension was filed

if you filed an extension you could set up a SEP for 2005, otherwise you would only be able to set up a plan for 2006 and beyond. I'll check my rolodex for a contact in CA on Monday when I get to the office and give you someone to call. What part of CA are you in? I lived in San Diego for 3 years, and my family lives in the Bay Area. My dad is in San Mateo, my grandmother is in Rodeo.

[gowithmygut]

I am in the central valley. I'm am probably covered as far as setting something up if that is what we choose to do. I'm really trying to get a feel for whether it is something that I should bring up with the partners and whether there is any benefit for us. In my original posting I mentioned that I had contributed $19K to a 401K. That should have been 19K (14K + 5K catch up) in 2005. I say that because I am unclear if the 15K limit for 2006 is a factor in setting up a new plan. All the partners are likely at the 401K limit.

My self employment income comes from a partnership (eight individuals [one CPA] that have between a 10-20% interest). The 1065 for 2005 shows approx 500K business income. It appears that we could set up an SEP, however I become confused when it comes to the calculation of the contribution amounts to the individual partners because depreciation is such a large factor in this partnership approx 250K. The K-1s for each partner note that there are other deductions on Part 3 line 13, however they are not actually subtracted from the amount showing the line 14 SE earnings. Each partner has a differing amount of depreciation. If the partnership were to set up an SEP and wanted to use the max 25% what is multipled by?

It seems that the other option is that I set up a SEP. In that case I believe that I have to reduce the gross income by the depreciation before the 25% caluclation. Is that correct? It also seems that the partnership could set up an SEP and I could also. If that is the case what contribution limits come into play.

I'm trying to educate myself enough to engage in an intelligent discussion. Thanks for the help.

[JoshinNC]

A SEP by the partnership wouldn't benefit you,

As you most likely don't take a wage from the partnership. Any moneies you take should be in the form of Guaranteed Payments (SE income) or distributions (return of basis). So, if the partnership sets up a SEP there would be no wages for you to base a contribution on. You can, however, start your own SEP. The calcualtion would be as follows:

Net SE from K-1 - 1/2(Net SE from K-1 x 14.16%) x 20%

This is a long way of saying your SE income minus 1/2 of SE tax multiplied times 20%. Your adviser should be able to look at your personal return and come up with the amounts. You can talk to the partners about a plan for the partnership, but I don't see any personal benefit in it for you, or them.

[Bees Knees]

As you most likely don't take a wage from the partnership. Any moneies you take should be in the form of Guaranteed Payments (SE income) or distributions (return of basis). So, if the partnership sets up a SEP there would be no wages for you to base a contribution on. You can, however, start your own SEP. The calcualtion would be as follows.

I disagree.

IRS Pub 560, page 4 says the following:

“Employer. An employer is generally any person for whom an individual performs or did perform any service, of whatever nature, as an employee. A sole proprietor is treated as his or her own employer for retirement plan purposes. However, a partner is not an employer for retirement plan purposes. The partnership is treated as the employer of each partner.”

That means you cannot set up your own SEP based on partnership income. A SEP for a partner would have to be set up through the partnership.

On page 5 of IRS Pub 560, it says,

“Net earnings from self-employment. For SEP and qualified plans, net earnings from self-employment is your gross income from your trade or business (provided your personal services are a material income-producing factor) minus allowable business deductions…..”

A few paragraphs later, it says,

“Net earnings include a partner’s distributive share of partnership income or loss (other than separately stated items, such as capital gains and losses). It does not include income passed through to shareholders of S corporations. Guaranteed payments to limited partners are net earnings from self-employment if they are paid for services to or for the partnership. Distributions of other income or loss to limited partners are not net earnings from self-employment.”

So in other words, if you want to have a SEP for a partner in a partnership, then the partnership has to set up the SEP. The contributions made by the partnership on behalf of the individual partners is based on their self-employment earnings, which includes the line one of Schedule K-1 ordinary income, plus guaranteed payments. However, if you are a limited partner, and your only self-employment income is from guaranteed payments, then your SEP contribution can only be based on the guaranteed payments.

For those who choose to take the position that an LLC member's line 1, K-1 profits are not subject to SE tax due to their limited liability status, then the SEP contributions could only be based on their guaranteed payments.

[JoshinNC]

I think I agree

What Bees is saying is correct, per Publication 560.

[Unregistered]

Thanks for the information. After my weekend of reading it seems to me that the partnership may elect to set up an SEP. It isn't clear to me that a partner is disallowed to set up their own SEP base on SE income. Isn't the partner recognized as both an employee and an employer? Thanks for all the help.

[Bees Knees]

It isn't clear to me that a partner is disallowed to set up their own SEP base on SE income. Isn't the partner recognized as both an employee and an employer? Thanks for all the help.

No, the partner is not recognized as both an employee and an employer. IRS Pub 560, page 4 says:

“Employer. An employer is generally any person for whom an individual performs or did perform any service, of whatever nature, as an employee. A sole proprietor is treated as his or her own employer for retirement plan purposes. However, a partner is not an employer for retirement plan purposes. The partnership is treated as the employer of each partner.”

[gowithmygut]

I'm good. Thank you for the thoughtful assistance.