401k Limits

[Randall]

An S Corp, one shareholder, one employee, himself.  My understanding of the 401 limits is a dollar limit for the employee contribution of $20,500 as long as there is W2 compensation to that limit.  His W2 is $62,750.  My understanding is that the employer contribution is limited to 25% of the compensation ($62,750 at 25% = $15,687).  My reading says this limit is the allowable deduction.  But does this mean the employer can contribute more, just can't take the excess as a deduction?  The max dollar amount for the employer is $40,500.  Does this mean the employer can contribute $40,500 but can only take a deduction of $15,687?  If so, the S Corp profit will increase by $24,813 and shareholder will pay tax on the additional $24,813 as pass thru income.  Further, client has employee contribution going into a Roth.  He wants to convert the employer contribution to a Roth each year.  If I understand this correctly, I want to advise him to keep the employer contribution to the 25% limit.  Otherwise, I think he'll pay double tax on the $24,813.  As pass thru income (higher S Corp profit) and again when the conversion from regular to Roth account.

[Lee B]

There are some variations on the standard 401 k that affects the answers. Solo 401 k, 401k safe harbor or ?

 

[Randall]

1 hour ago, cbslee said:

There are some variations on the standard 401 k that affects the answers. Solo 401 k, 401k safe harbor or ?

 

I'm not seeing any difference in my situation.  A solo plan is simply a 401k plan that has only one participant (or spouse) and is self-employed.  I don't think an S Corp shareholder is considered a self-employed person.  A safe harbor plan is one that has employer contributions fully vested and doesn't have to deal with nondiscrimination rules.  I'm still left with my original question.

 

[Lee B]

Why don't you look at the Plan Document or contact the Fiduciary?

[Randall]

45 minutes ago, cbslee said:

Why don't you look at the Plan Document or contact the Fiduciary?

I'll check.  But if anyone else has some thoughts on this, let me know.

 

[Medlin Software, Dennis]

An S Corp shareholder/employee IS considered an employee and a self employed person, depending on who is asking...  I am no expert on this, but taking the OP at face, if the amount beyond the allowed amount is given, it would itself become taxable wages.

[jklcpa]

Employer contributing more than 25% of the defined compensation per plan document would result in a nondeductible excess contribution, and the employer would be subject to the excise tax if not remedied.

[Lee B]

Again it depends on the plan document. I believe plans can be written so that the employer contribution can exceed 25 % of compensation as long as the combined employee/employer contributions doesn't exceed the designated max of $61,000 for 2022 or 100% of  compensation whichever is lower.

[jklcpa]

20 minutes ago, cbslee said:

Again it depends on the plan document. I believe plans can be written so that the employer contribution can exceed 25 % of compensation as long as the combined employee/employer contributions doesn't exceed the designated max of $61,000 for 2022 or 100% of  compensation whichever is lower.

I think the employer contribution is still limited to the 25% but the employee elective deferral can be up to 100% of the plan doc's comp as long as the total combined contribution max doesn't exceed the $61,000.

https://www.irs.gov/retirement-plans/one-participant-401k-plans

[Lee B]

You are correct with respect to the limit on Employer Matching Contributions, however many plans also allow "Nonelective Employer Contributions"

for which the 25% of compensation does not apply:  

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

"Overall limit on contributions

Total annual contributions (annual additions) to all of your accounts in plans maintained by one employer (and any related employer) are limited. The limit applies to the total of:

elective deferrals (but not catch-up contributions)
 

employer matching contributions
 

employer nonelective contributions
 

allocations of forfeitures"

[Lee B]

To further clarify, Employer Nonelective Contributions are voluntary, the Employer has no obligation to make these contributions.

In the right circumstances with the cash available, they would be a good tax planning tool.

With enough time to read, it's amazing what you can learn.   

[jklcpa]

Thank you. I'll take some time tomorrow to read the links and examples more closely.

[Randall]

I'm still a little confused on the difference between EmployER matching and EmployER nonelective contributions.  cbslee, are you saying if the employer plan desginates the employer will match the employee's elective deferral amount, then the employer can also contribute up to 25% of the employee's salary in addition to the matching amount?  So in my case, the employee has elected to defer $20,500 (2022 dollar limit).  If the plan allows for matching, the employer can then match the $20,500.  This would total $41,000.  Then the emloyer can make a nonelective contribution up to 25% of his salary (Salary of $62,750 at 25% or $15,687.  This would total $56,687, still within the total limit of $61,000 for 2022.  I'm still not finding a reference for this distinction in your links.

[Lee B]

First you need to refer to your Plan Document to see what your client's plan allows.

Second the Fiduciary for your clients plan employees people who are experts in this area,

who would be the most knowledgeable people to answer your questions.

For example if the plan allows Employer Nonelective Contributions, the employee could contribute $ 0 and the employer could make

a Nonelective Contribution of the max $61,000.

[Randall]

20 minutes ago, cbslee said:

First you need to refer to your Plan Document to see what your client's plan allows.

Second the Fiduciary for your clients plan employees people who are experts in this area,

who would be the most knowledgeable people to answer your questions.

For example if the plan allows Employer Nonelective Contributions, the employee could contribute $ 0 and the employer could make

a Nonelective Contribution of the max $61,000.

I'm not sure he has a formal plan.  I asked him to contact the Fiduciary.  But I still can't find the Tax references to the limits in the way you're stating.

 

[Lee B]

3 minutes ago, Randall said:

I'm not sure he has a formal plan.

 

He has to have a formal plan even if it's just boilerplate. Why don't you do a conference call with your client and his Fiduciary.

[Lee B]

31 minutes ago, Randall said:

  But I still can't find the Tax references to the limits in the way you're stating.

 

January is my busiest month due to 4th Quarter and Year End Payroll Reports, so I don't have any more time to spend on this area.

The objective of my posts was to point out that this is an area which is more complicated than it first appears,

which is why I keep referring to the client's Plan Document and to the client's Fiduciary who has expert advice available.

[Medlin Software, Dennis]

54 minutes ago, Randall said:

I'm not sure he has a formal plan.

Bingo!  Given a one person entity, the odds are good there is no formal plan.

[Randall]

31 minutes ago, cbslee said:

January is my busiest month due to 4th Quarter and Year End Payroll Reports, so I don't have any more time to spend on this area.

The objective of my posts was to point out that this is an area which is more complicated than it first appears,

which is why I keep referring to the client's Plan Document and to the client's Fiduciary who has expert advice available.

Thanks for your comments.  I understand the busy time.  I did find Pub 4222 which seems to support your comment about if employee elected zero contribution, then employer could still contribute $61,000.  The wording in Pub 4222 says employer decides the percentage of compensation to contribute, which could be 100%.  Client is talking to Fiduciary and will have the plan documented.  His question to me was if he has already contributed too much and if he needed to withdraw the excess.  Thanks again for your help. 

[Randall]

15 minutes ago, Medlin Software, Dennis said:

Bingo!  Given a one person entity, the odds are good there is no formal plan.

It was probably a boilerplate.  Client is talking to the Fiduciary and they will have the plan.  Ha.

 

[Randall]

I'm still puzzled as to what the 25% applies to.  Seems contradictory.

[Lee B]

1 hour ago, Randall said:

I'm still puzzled as to what the 25% applies to.  Seems contradictory.

The 25% applies to Employer Matching Contributions

[Medlin Software, Dennis]

1 hour ago, Randall said:

I'm still puzzled as to what the 25% applies to.  Seems contradictory.

Just finances/taxation.  One cannot call it sensible in any manner <smile>.  If puzzling, consider refraining from offering the client any advice until it becomes more clear.  With a plan, the plan manager can answer their contribution questions, and you can just do what the client wants (unless it is objectionable to you).  Keeps you from being liable for giving the advice or numbers to go on.

[Randall]

15 hours ago, Medlin Software, Dennis said:

Just finances/taxation.  One cannot call it sensible in any manner <smile>.  If puzzling, consider refraining from offering the client any advice until it becomes more clear.  With a plan, the plan manager can answer their contribution questions, and you can just do what the client wants (unless it is objectionable to you).  Keeps you from being liable for giving the advice or numbers to go on.

Yes, I've referred him to his Fiduciary for the Plan specifics and to verify with the Fiduciary's tax department, not just his rep.

[Randall]

I'm still waiting on the client talking to his Fiduciary.  But I keep seeing that the 25% of compensation applies to the limit the employer can take as a deduction.  In other words, employee elects to defer $20,500 so that is a deduction as Salary.  The employer can contribute up to 100% of compensation (assuming the plan allows).  So an additional $40,500 (getting up to the overall limit of $61,000).  But the employer would only be allowed to deduct $15,687 (25% of the salary of $62,750).  This would leave an allowed contribution of $24,813 but not allowed as a deduction.  So the S Shareholder would be reporting an additional pass thru income of $24,813.  Not a big deal except if the person wants to then convert it all to a Roth.  Then would the $24,813 be double taxed.