Partnership Roth 401k contributions, really a deduction?

[qofmiwok]

My partnership made Roth 401k contributions for its  members.  It shows up on the K1 as Line 13 Code R.  But Line 13 says Deductions, and a Roth 401k isn't deductible.  So is that the right place for it?

Also, the partnership should not take a deduction on 8825 for it, correct?  That makes sense to me because it were a traditional 401k contribution I would deduct it from my K1 income on my personal return, but since it's a Roth IRA I don't.  The partnership has to include it in income or it would never be taxed.

[Opus 17]

I think that may be illegal.

[Edited: see @dmertz 's answer for how to report this.]

I know that for any other corporation, non-profit, etc., if the company makes a retirement contribution (matching contribution, free money, etc.) it must be contributed to a pre-tax account, even if the employee has chosen to put their salary deferrals into a Roth-option account in the 401k or 403b plan.

Here, because partnership profits are taxed to the individual partners on a K-1, if you make Roth contributions and don't count them as distributed profits, you have essentially dodged the tax on those profits, which is quite illegal.

There are also important rules about participating in retirement plans if you own the business.  I don't know those rules but you need to take them into account.

I think it may be allowable to contribute matching funds to a pre-tax 401k account, because the partner will eventually pay tax on the money when they convert it to a Roth or withdraw it.  The 401k plan would be a deductible employment expense.  But I think you have a huge problem if you contribute partnership funds to a Roth plan.

@dmertz 

@rjs 

[dmertz · Accepted solution]

@Opus 17 , the changes made by Section 604 of the SECURE 2.0 Act allows the employee to elect that employer contributions are to be made as Roth contributions, plan permitting:

https://www.irs.gov/newsroom/secure-2-point-0-act-changes-affect-how-businesses-complete-forms-w-2

Notice 2024-2 Q&A L-9 indicates that the contribution is to be treated as a regular traditional IRA contribution followed immediately by an in-plan Roth rollover (without regard to any after-tax amounts in the traditional 401(k) account that would otherwise trigger prorating of the taxable amount), so in combination with reporting the employer contribution with code R in box 13 of the Schedule K-1 (Form 1065), the plan should have issued (or will issue if Schedule K-1 is reportable on the 2024 tax return instead of the 2023 tax return due to the plan using a fiscal tax year) a code G Form 1099-R reporting the entire employer contribution as taxable.

This means that the reporting on the Schedule K-1 is correct and the partnership gets a deduction for the contribution.  The employee pays the tax on this employer contribution.

[Opus 17]

---

@dmertz wrote:

This means that the reporting on the Schedule K-1 is correct and the partnership gets a deduction for the contribution.  The employee pays the tax on this employer contribution.

---

Thanks.  Treating it as a pre-tax contribution and immediate rollover makes sense (I think) because that way, the partner does pay the tax (which is what I was worried about.)

[qofmiwok]

Let me make sure I understand.  In TT Business it asked about Partnership Retirement Contributions.  I entered an amount.  But does that only mean employer contributions, or does it also mean employee contributions?  
 

Next, you say the partnership takes a deduction.  But TT Business is not taking a deduction, it's just reporting it on Line 13 but the amount paid is still included in total income.  Are you saying the Partnership should manually enter a deduction similar to how Guaranteed Payments for Health Insurance get entered?  Then the Retirement Plan Administrator issues a 1099 Code G reporting a taxable Roth conversion, so the Partner pays tax on it?  

But again, is this all just for Employer contributions?  How are Employee contributions handled?

The IRS says the following which implies that Roth deferrals are NOT excluded from the employee's taxable income in the year they are made.  So do I would argue that for employee contributions the Partnership does NOT take a deduction, just passes through the amount so the employee either gets a deduction (if traditional and if within limits) or not (if Roth or otherwise not eligible). 

IRS: A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.

• Elective salary deferrals are excluded from the employee’s taxable income (except for designated Roth deferrals).
• Employers can contribute to employees’ accounts.

[dmertz]

Sorry, what I should have said is that the partner (not the partnership) gets the deduction via the amount reported with code R in box 13 of the Schedule K-1 but is also taxed on the same amount via the code G Form 1099-R.

[qofmiwok]

What about employee contributions?  

[qofmiwok]

My plan administrator said employee elective Roth contributions don't get reported on any tax form.  Line 13 R is only for employer contributions.  So I think I need to removed the employee contributions from the partners K1's.  

[Opus 17]

---

@qofmiwok wrote:

My plan administrator said employee elective Roth contributions don't get reported on any tax form.  Line 13 R is only for employer contributions.  So I think I need to removed the employee contributions from the partners K1's.  

---

Employee Roth 401k contributions are reported on their W-2 in box 12 using code AA.  I don't know about partners. 

[dmertz]

Both employee and employer contributions are to be included in box 13 with code R.  It's then your responsibility to correctly allocate within TurboTax the total code R amount between employer (traditional and Roth) and employer contributions.