Employer deductions for 401K contributions?

[csciora]

My CPA just informed me my business can't deduct the 401K contributions that I have withheld from each paycheck. It's a C corporation with a self-directed 401K plan. Kind of hard to believe that I'm only discovering this now and I truly don't understand why it's treated differently than salary. That's a pretty hefty tax penalty on $18,000 in employer contributions. Maybe enough of a tax penalty that contributing doesn't even make sense for me instead of taking it as salary and putting it into non-tax deferred investments.

However, regardless, it looks like the employer contributions are legitimate business expenses. At least the "matching" part maybe.

1. Is that the part about employer contributions not being deductible really the case?

2. Does that mean I shouldn't contribute personally to the 401K until the business contributes it's full $35,000 maximum in employer contributions?

At least the latter would be a deductible business expense...

I really can't believe never coming across this little detail before, so any good links or references would be great.

Thanks!

~ Chris

 

[DMFA]

Retirement Plans for Small Businesses: https://www.irs.gov/pub/irs-pdf/p560.pdf
Page 16: "Treatment of contributions. Your contributions to your own 401(k) plan are generally deductible by you for the year they are contributed to the plan. Matching or nonelective contributions made to the plan are also deductible by you in the year of contribution. Your employees' elective deferrals other than designated Roth contributions are tax free until distributed from the plan. Elective deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax."

The $18,000 in elective deferral is a salary reduction and counts as the employee's contribution, not the employer's.  The employee-you gets the tax break on elective deferrals, and the employer-you get the tax break on employer contributions, and they don't let you double-dip.  So while you-you gets $53,000 in your 401(k), employee-you gets a tax reduction on up to $18,000 and employer-you gets a tax reduction on the remainder.

The employer contributions should be deductible from the corp's taxes, like you said.  This should count for any other employees you have: https://www.irs.gov/pub/irs-pdf/p525.pdf, Taxable and Non-Taxable Income:
Page 9: "If you are covered by certain kinds of retirement plans, you can choose to have part of your compensation contributed by your employer to a retirement fund, rather than have it paid to you. The amount you set aside (called an elective deferral) is treated as an employer contribution to a qualified plan. An elective deferral, other than a designated Roth contribution (discussed later), is not included in wages subject to income tax at the time contributed. However, it is included in wages subject to social security and Medicare taxes."

See also 401(k) Plans for Small Businesses: https://www.irs.gov/pub/irs-pdf/p4222.pdf

[The White Coat Investor]

Employer 401(k) contributions are a business expense (i.e. compensation for employees) so they should be deductible. I doubt your CPA doesn't know this so I suspect miscommunication/misunderstanding.

Employee 401(k) contributions were deducted by the business when they were paid to the employee as salary. The employee gets to deduct them on his taxes. When he pulls the money out, he then pays tax on it.

[csciora]

I love the employee-you and employer-you terminology. ;-)
Thanks for the links. It's been surprisingly difficult to find that basic information about the business deductions. All the articles seem to skip right to the non-elective contributions / profit sharing aspect. After processing this new information a bit, it seems the right strategy for me at the moment is:

1. Employer-you contributions up to the full $53,000 capped at 25% of salary.

That maximizes business tax deductions, but is currently limited by my annual salary which is under $212,000.

2. Additional employee-you contributions capped at $18,000 (if not already capped by #1).

I'm just not sure whether maxing out the employee-you contributions even makes sense. My effective business and personal tax rates are roughly similar. It feels like just taking the money as a bonus and putting it into a regular investment account is better than double taxation. At least the front end of the bonus would be a deduction for the business. We're really not expecting our personal tax rate to decline after "retirement".

Another pieces of IRS tax trivia that I've hopefully long forgotten when sailing in the Caribbean sometime next decade.

[DMFA]

It's not really double-taxation, I guess...in fact, the rule as it stands basically prevents you from double-deducting.  That way, neither you nor the government can double-dip.

It might be best to take your own contributions entirely outside of elective deferrals since they're subject to few taxes, since elective deferrals still pay FICA. Here's a good bogleheads post on the subject: https://www.bogleheads.org/forum/viewtopic.php?t=101210#p2453043