What counts for earned income for Roth purposes?

Forum|Forum|4 years ago
March 6, 2022
1 reply
4 views

I'm getting a warning saying I overpaid my Roth because I didn't have enough "earned income". I pay myself a small salary for a SubS corp and get a K1. When I look at the IRS document

it says that it's Line 11 from my 1040, not "earned income". Does the K1 income count?

This has been the same situation for several years and I've never had this problem.

TurboTax Home & Biz Windows

Best answer by Opus 17

@rvhatcher wrote:

Thanks, I understand now. But what's strange is that I had the same situation last year and it didn't trigger the warning. It's disappointing that the K1 which is income I earned in my little consulting company doesn't count.

If you have an S-corp, you must pay yourself a salary on a W-2 that represents fair compensation for the work you performed for the business, and it really should be equal to what you would have to pay someone else to manage the business or perform the same tasks. If the business has income that is more than the fair compensation for your own work, that flows to you on the K-1. (Passive income you earn off other people's work in the business, which is not the same as compensation for your own work.) It is illegal to set your compensation low for purposes of avoiding employment taxes.

You can only contribute to the IRA up to your compensation for work performed. You determined that your fair compensation for work performed was less than the amount you want to contribute to the IRA. It's your W-2 that controls, not some unfair IRS regulation. If your W-2 compensation is too low, you need to pay yourself a higher salary and pay the employment taxes that go with it. (W-2 compensation for S-corp owners is a leading audit issue, by the way.)

D

dmertz

Level 15

Your compensation is the amount in box 1 of your W-2 minus any amount in box 11. Nothing on the Schedule K-1 (Form 1120-S) is compensation.

The reference you provided is not a reference that defines compensation. It references Modified AGI for determining whether or not your income (not just compensation) is too high to make the contribution. The definition of compensation is in IRS Pub 590-A:

https://www.irs.gov/publications/p590a#en_US_2021_publink1000230355

R

rvhatcherAuthor

Level 4

Thanks, I understand now. But what's strange is that I had the same situation last year and it didn't trigger the warning. It's disappointing that the K1 which is income I earned in my little consulting company doesn't count.

O

Opus 17

Answer

Level 15

@rvhatcher wrote:

Thanks, I understand now. But what's strange is that I had the same situation last year and it didn't trigger the warning. It's disappointing that the K1 which is income I earned in my little consulting company doesn't count.

If you have an S-corp, you must pay yourself a salary on a W-2 that represents fair compensation for the work you performed for the business, and it really should be equal to what you would have to pay someone else to manage the business or perform the same tasks. If the business has income that is more than the fair compensation for your own work, that flows to you on the K-1. (Passive income you earn off other people's work in the business, which is not the same as compensation for your own work.) It is illegal to set your compensation low for purposes of avoiding employment taxes.

You can only contribute to the IRA up to your compensation for work performed. You determined that your fair compensation for work performed was less than the amount you want to contribute to the IRA. It's your W-2 that controls, not some unfair IRS regulation. If your W-2 compensation is too low, you need to pay yourself a higher salary and pay the employment taxes that go with it. (W-2 compensation for S-corp owners is a leading audit issue, by the way.)