In the Summer 2011 edition of Retirement News for Employers, the Internal Revenue Service (“IRS”) discusses how to define “compensation” for a partner for purposes of qualified retirement plans. Here is what the IRS said.
A partnership makes annual contributions to a partner’s retirement plan account based on her net earned income. For a partner, net earned income is calculated in the same way as for most other self-employed plan participants, by starting with the partner’s earned income and then subtracting:
• plan contributions for the partner, and
• half of her self-employment tax.
Pub. 560 has tables and worksheets to calculate the deduction for contributions to a qualified retirement plan for a partner.
A partner’s earned income is the income she receives for her services to materially help produce that income (see Code §§1402 and 401(c)(2).) A partner must separately calculate her earned income for each trade or business. Not every partner may have earned income (for example, a limited partner who does not provide services to the partnership and is merely an investor). Also, all of a partner’s income from the partnership may not be earned income (for example, investment income that is passed through the partnership to the partners).
Each partner’s earned income or loss is listed on Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc. The partnership must give a Schedule K-1 to each partner by the filing due date (including extensions) of the partnership’s Form 1065, U.S. Return of Partnership Income.