retirement contribution through partnership LLC or on personal return

[esayer]

I am in a a 2 person LLC partnership with my wife.  are we better off making retirement contributions from the LLC or on our personal returns basing the contribution on our K-1 income?

[Anonymous_]

@dmertz 

[Opus 17]

One factor is contribution limits.  For a personal IRA, you can contribute up to your compensation from working, with a maximum of $6500 (or $7500 if over age 50).   With a self-employed IRA (SEP-IRA), the contribution limit is 25% of your business income up to about $66,000.

https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep

So if your LLC profit is $5000 per person and that's your only income, a personal IRA will allow you to contribute up to $5000 but an SEP-IRA would be limited to $1250.  If your LLC profit was $50,000 per person, a personal IRA would be limited to $6500 or $7500, but an SEP-IRA would allow up to $12,500.

There are other kinds of plans, other rules, and more expert advice is needed.  But that is one factor to consider.  

[esayer]

thank you.  that is very helpful.  

ed

[dmertz]

Opus 17's example for a SEP IRA is incorrect.  First, any employer plan with respect to the partnership must be established under the partnership.  In the case of a SEP-IRA, contributions must be made for both partners using the same base percentage of compensation.  Second, because the deduction for SEP contributions would be taken on the partner's individual tax return(s), the contribution is limited to 20% of net earnings.  Net earnings are the individual's net profit minus the deductible portion of self-employment taxes.

So if each partner has net profit of $5,000, each individual's net earnings would be $4,646 (assuming that the Social Security wage limit is not maxed out with due to also having another employer), resulting in a maximum permissible SEP contribution for each partner of $929.  The amount contributed on behalf of each partner must be the same, either by each partner making the SEP contribution to their separate SEP-IRAs under the partnership's plan or the partnership making those contributions under the plan.

The SEP-IRA contribution limit is separate from the IRA contribution limit, but the total of the individual's deductible portion of self-employment taxes, a self-employed retirement deduction and an IRA contribution is not permitted to exceed net profit from self-employment.  Note that the Schedule K-1 from the partnership will show in box 14 with code A the individual's net profit from self-employment.

[Opus 17]

a. I am aware of the limitation due to 1/2 the self-employment tax, I was making a rough estimate for illustration purposes.  If the taxpayer's income is low, the IRA has a larger contribution limit, if the business profit is large(er), the SEP-IRA has a higher contribution limit.

b. The 20% limit for owners (instead of 25% limit for employees) was obscure for me to find.  It is not given here SEP contribution limits but I did find it here Publication 560 although I had to control-F to find it.  

c. Other options besides an SEP-IRA appear to include a self-employment 401(k) and a SIMPLE IRA.

https://www.irs.gov/retirement-plans/retirement-plans-for-self-employed-people

@dmertz do you have any thoughts on pros or cons of various plans for a spousal 2-person LLC? 

[dmertz]

Because it allows employee elective deferrals where a SEP plan would not, a solo 401(k) plan would allow at least as much to be contributed as could be contributed to a SEP plan.  Whether the additional complications of establishing a solo 401(k) plan rather than a SEP plan would depend on the amount of net earnings, the amount of desire to make retirement contributions and how much tolerance there is for the greater limitations on access to the funds before age 59½.  A SIMPLE IRA plan might be a reasonable choice under limited circumstances but comes with some substantial restrictions that might make it not worth the trouble.