Over Funded 401k
I have a client who was W-2 part of the year and self employed part of the year.
While w-2 he contributed $22,000 to his 401k – his company added $3,600.
This is his max for the year.
When self employed he contributed $2329 to his Individual 401k based on sole proprietor net income of $7050.
It appears the most he could contributed to the Individual 401k for the employer part would have been $1762.50.
What needs to be done with the excess? What forms do we need to file with the IRS?
Thanks
Permalink Submitted by Alan Spross on Wed, 2011-05-18 20:39
There is an excess deferral of $566. But that should have been requested as a distribution from either plan and distributed with any earnings prior to 4/15. An extension does not extend that date.
Since the deadline has passed, there is no sense in taking out the excess now because it will be taxed both in 2010 and 2011 and the earnings on it in 2011 also. Either way, it must be included in income on line 7 of the 2010 return. But by leaving the excess deferrals in the plan the second distribution can be delayed until retirement. Yes, it will eventually be taxed twice, but the earnings stay in and will generate more earnings over the years.
Therefore, all he needs to do now is add the $566 on line 7 (wages) of the 2010 tax return.
Permalink Submitted by Martin Helmer on Fri, 2011-05-20 23:54
Here’s an alternative interpretation of the situation: Instead of having an ‘excess employee deferral’ we have a possible ‘nondeductible employer contribution.’ I assume the 2 employers are unrelated. To get to $2,329 as the originally calculated limit, it appears the $7,050 of self employment net income was multiplied by 25%. But self employment income must effectively be reduced by both half the self employment tax and by the profit sharing contribution itself, before using the 25% factor. For example, if half the self employment tax is assumed to be $539.33, then the profit sharing contribution limit is 20% ($7,050 minus 539.33), or $1,302. Proof: 25% ($7050-1302-539) = $1302.
The nondeductible amount would then be $2329-1302 = $1027. “Employer” contributions often are not permitted to be removed from the plan. The $1027 would typically then become part of the 25% limit for 2011 and can be deducted then, assuming self employment income supports this. There’s no penalty if at least $1027 was physically contributed after 12/31/10. But if the entire $2329 was contributed prior to the end of 2010, then a Form 5330 needs to be filed along with a payment equal to 10% of the ‘nondeductible contribution’, which is $103. The 2010 Form 1040 should show $1302 as the deduction for ‘self employed retirement plan.’