Business profit $9026. I put $5000 in my Roth, wife $4000 in hers. TT reports $500 excess in her contribution. Why is there an excess?

[Carl]

Is this a sole proprietorship business being reported on a SCH C? If so, who is the owner of the business? For a SCH C business, there can only be one owner, regardless of your maritial status or filing status. My bet is, you and you alone are the listed business owner. So your contribution is fine. But if your wife doesn't have at least $4000 of income that *she* earned, then you can't contribute to her ROTH.

[SweetieJean]

Is it a SEP?  If so, the maximum contribution is your net profit, minus one-half of the self employment tax.

[SweetieJean]

@Carl   It could be a spousal IRA. Otherwise, her entire $4000 would be too much (not just the $500).

[Carl]

My response is assuming that your wife is not a W-2 employee of the business you own. (No reason why she could not be.)

[johnstaxes]

Thanks for all the responses.  I did not understand from the information I had read that the earnings on which the contribution is based are reduced by half the self-employment tax.  Now I have to fix the problem.

[macuser_22]

If you already made the contributions then you fix it by removing the excess from one of the IRA's (I suggest only one so not to have 2 removals to report).  You tell the IRA custodian that this is a "return of contribution" due to an excess contribution and not a normal distribution.  The custodian must return the excess and any earnings generated by the excess and will issue a 1099-R coded to show the return and any earnings.  If this was a 2017 contribution and removed in 2018 you probably will not receive the 1099-R until next year, but if any earnings, those will be taxable in 2017 which will probably require an amended 2017 tax return to report it.

[johnstaxes]

Thank you, I will do that.

[macuser_22 · Accepted solution]

if that was your total earned compensation for 2017, then  it must be reduced by the deductible part of the SE (Self-Employment) tax which is 15.3% of your income.  The deductible part would be half of that.    That probably accounts for the excess.

See IRS Pub 590B "What Is Compensation?"

https://www.irs.gov/publications/p590a#en_US_2016_publink1000230355

Self-employment income.

If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) 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.

[Hal_Al]

9026 x 0.153 = 1381.  1381 x 50% = $690.
9026 - 690 = $8336 maximum contributions to both spouse's IRAs

[johnstaxes]

Hal_Al:
After further searching, I get the same result by a different calculation.  The maximum IRA contribution is equal to net earnings, defined as profit x 0.9235, in my case 9026 x 0.9235 = 8336.
Apparently the difference between profit and net earnings is Social Security and Medical payment.  
SE tax is net earnings x 0.153 = 8336 x 0.153 = 1275, which is what TT comes up with.  Half of that amount becomes a deduction on the personal tax calculation.

[dmertz]

Neither calculation above is correct.  The correct calculation is:

$9,026 × 0.9235 × 0.153 = $1,275  SE tax
The deduction for ½ SE tax = $638
$9,026 - $638 = $8,388 maximum combined IRA contributions.

This is the calculation that TurboTax performs.

[Hal_Al]

dmertz is correct.

Multiplying by .9235 may appear weird, but there's a rationale behind it. W-2 employees essentially get the benefit of the employer paid part of FICA tax free. This multiplier puts the self employed on the same footing