Calculating self-employed compensation for IRA contribution and deduction

[trittsd]

I am having trouble understanding the rules about contributing to an IRA when the only earned income is from self-employment and dividends.  Situation:

• Married couple filing jointly
• Both taxpayers under age 50
• SE spouse has a solo 401k tied to the business
• One spouse has self-employment income of $48250, other spouse has no earned income.
• Interest income: $4119
• Capital gains and dividend income: $63947
• Self-employment tax deduction (1040 Schedule 1 Line 15): $3409
• Self-employed SEP, SIMPLE, and qualified plans (1040 Schedule 1 Line 16): $31468
  SE spouse contributed $22500 to solo 401k as employee and $9148 to solo 401k as employer profit sharing.  
• Self-employed health insurance deduction (1040 Schedule 1 Line 17): $8135
• Adjusted Gross Income (1040 Line 11): $73,304  (without IRA deduction) 

Turbo Tax is suggesting to contribute and take deduction of 2 x $6500 for each spouse's IRA.  However, I am concerned that exceeds the earned income (taxable compensation).  

So, I'm wondering how much is the earned income (taxable compensation) for purpose of IRA contributions (and deductions).  Is it $48250 - (3409 + 31468 + 8135) = $5238?  Or, is that modifying the net earnings improperly (see below)?

IRS instructions state that maximum IRA contribution for 2023 is lesser of:

• $6500
• taxable compensation

For self-employment income, Pub 590-A states "compensation is the net earnings from your trade or business ... reduced by the total of:

• The deduction for contributions made on your behalf to retirement plans, and
• The deduction allowed for the deductible part of your self-employment taxes.

Question 1: Is "deduction for contributions made on your behalf to retirement plans" the elective 401k contributions made by the employee or the profit-sharing contributions made by the employer or both?

Question 2: Does the SE net earnings need to be reduced by the Self-employed health insurance deduction (1040 Schedule 1 Line 17) when determining the amount of compensation for purpose of IRA contribution limits?

Thank you for any help you can provide!

[dmertz · Accepted solution]

Income from self-employment that will support an IRA contribution, net earnings, is net profit minus the deductible portion of self-employment taxes.  Deductible contributions to a self-employed retirement plan further reduce the amount available to support an IRA contribution.  In other words, the amount that will support an IRA contribution is net profit minus the amounts on lines 15 and 16 of Schedule 1.  The self-employed health insurance deduction on line 17 does not reduce available compensation.

A traditional IRA contribution may or may not be deductible depending on your modified AGI for the purpose, whether you or your spouse is covered by a workplace retirement plan and your filing status.

In your case, both spouses are eligible to contribute to a traditional or Roth IRA.  The total compensation available to support these contributions is $48,250 - ($3,409 + $31,468) = $13,373, just enough to support the maximum $6,500 IRA contribution for each of you.  If made to a traditional IRA, the contribution is eligible to be deducted on Schedule 1 line 20.  (It would make no sense to choose to treat a traditional IRA contribution as nondeductible since it would be better to just make the contribution to a Roth IRA instead.)

[trittsd]

@dmertz Thank you so much for your help with a clear response!