Maximum Deduction to SIMPLE or 401(k) for Self-Employed
The Pacific Life calculator (see link below) has different formulas for calculating Earned Income for (1) a SEP or individual 401(k) or (2) a SIMPLE.
(SEP IRA and Individual (k)) Earned Income = Net Profit – 1/2 of Self-Employment Tax – Contribution
(SIMPLE IRA) Earned Income = Net Profit – 1/2 of Self-Employment Tax
Link to Pacific Life website calculator:
http://www.calcxml.com/calculators/qua12?skn=382#calcoutput
[b]Question[/b]: Why are the formulas for Earned Income different for different types of plans?
Consider a self-employed person under age 50 with Schedule C net profit of $10,000 for 2012 and a plan other than a money purchase Keogh, i.e. a plan without a fixed contribution percentage, and no Roth contribution. The Deduction Worksheet for Self-Employed on page 22 of IRS Publication 560 provides the following calculation of the maximum deductible contribution:
Step 1 Net profit $10,000
Step 2 Deduction for Self-employment tax 706*
Step 3 Net earnings from self-employment (1)-(2) 9,294
Step 4 N/A, no money purchase plan contribution rate
Step 5 N/A, no money purchase plan contribution rate
Step 6 N/A, no money purchase plan contribution rate
Step 7 N/A, no money purchase plan contribution rate
Step 8 Contribution dollar limit 50,000
Step 9 Allowable elective deferrals made during 2012 -0- (thus far)
Step 10 (8) – (9) 50,000
Step 11 (3) – (9) 9,294
Step 12 One-half of Step 11 4,647
Step 13 Smallest of (7), (10) or (12) 4,647
Step 14 (3) – (13) 4,647
Step 15 Smaller of (9) or (14) -0-
Step 16 (14) – (15) 4,647
Step 17 Catch-up contribution -0-
Step 18 Smaller of (16) or (17) -0-
Step 19 (13) + (15) + (18) 4,647
Step 20 Roth contributions -0-
Step 21 Maximum deductible contribution (19) – (2) 4,647
*10,000 x 92.35% x 13.3% x 57.51% from portion of Schedule SE on p. 24 of Publication 560
This amount is exactly half the amount the Pacific Life website calculator obtains, $9,294, which I believe to be the correct answer.
[b]Questions[/b]: What mistake did I make using the worksheet? Why does Step 12 use one-half of Step 11, rather than the entire amount?
Permalink Submitted by Alan Spross on Wed, 2012-06-20 23:50
I am definitely not up to speed on these particular worksheets, but a partial explanation could involve the bold type on the worksheet after Step 8. You only advance to step 9 if you are dealing with elective deferrals. Elective deferrals would not include SEP IRAs or SIMPLE IRAs. Elective deferrals such as for a solo K WOULD have a set deferral % to enter and full completion of the worksheet lines.
For a SEP IRA, the table that shows the deduction as 20% factors in the subtraction for the contribution from the net earnings less 1/2 of SE.
Permalink Submitted by Eric H Silverman on Thu, 2012-06-21 00:17
I would consider a SIMPLE IRA contribution to be an elective deferral. It is not a mandatory conribution. if, however it is not co9nsidered an elective deferral and one skips Steps 9 through 20 and enters the smaller of Step 7 or Step 8 on Step 21, then the maximum deduction is [b]zero[/b].
Permalink Submitted by Alan Spross on Thu, 2012-06-21 02:08
It doesn’t appear that these worksheets even apply for a SIMPLE IRA contribution limit. Per p 22 of Pub 560, they are used for SEP IRA and qualified plan deduction limits.
Elective deferrals and salary reduction arrangements are functionally very similar. but technically apply to different types of plans. Elective deferrals apply to qualified plans. They also have different dollar caps, the elective deferral caps being higher than salary reduction limits for a SIMPLE IRA.
The SIMPLE IRA compensation limit for SEs is taken directly off Sch SE before subtracting any contributions made to the SIMPLE IRA for yourself. This limit operates along with the salary reduction limit in Sec 408p and the max contribution is whatever figure is lower. Then there is the catch up contribution also limited in two ways, by the dollar limit and also by the excess of compensation over the non catchup contributions.
Tough to determine exactly why there is such a lack of consistency between definitions used for different plans. I think these plans just evolved without any intent to simplify the rules.
Permalink Submitted by Eric H Silverman on Thu, 2012-06-21 03:39
Is there a worksheet, form instruction or other guidance from the IRS for the SIMPLE IRA contribution limitation for a self-employed person? If so, then what or where is it?
alan-oniras writes:
[i]The SIMPLE IRA compensation limit for SEs is taken directly off Sch SE before subtracting any contributions made to the SIMPLE IRA for yourself. [/i]
My questions:
What is the source for this rule? Is the individual 401(k) compensation limit for self-employed individuals calculated differently?