Solo 401k Profit Sharing Contribution

[wes6]

I am a sole proprietor and have a Solo 401k retirement account. This type of retirement account allows for employee (elective deferrals) and employer (profit sharing contribution) contributions. In this case I am both the employee and the employer because I am a sole proprietor. I made the maximum $19,500 "employee" elective deferral as well as an "employer" contribution. The elective deferral lowered my federal and state tax burden. However, when I enter the profit sharing contribution I see no tax benefit for federal tax purposes (i.e. this does not lower the amount that I owe, according to TurboTax). However, the profit sharing contribution does lower my state tax burden. I've already calculated the non-elective contribution limit for profit sharing purposes and I am under the limit, but see no federal tax benefit when entering the employer matching (profit sharing) contribution in TurboTax. Any help would be appreciated. 

[dmertz]

If your federal taxable income without the employer profit sharing contribution is already zero, adding the profit sharing contribution will not further reduce your taxable income or your tax liability.  However, you'll still be subject to self-employment tax.  Self-employment tax is determined by your net profit from self-employment and is not affected by any deductions that you claim on your federal tax return.

Also note that TurboTax has not yet been updated with the 2020 elective deferral limits and is still using the 2019 limits.  Since you made an elective deferral of $19,500, TurboTax is presently (version R14.1) calculating an incorrect self-employed retirement contribution in your case.

[wes6]

Thank you for the response, I appreciate it. My federal taxable income is greater than $0 even with the profit sharing contribution taken into account. I was under the impression that a profit sharing contribution was treated as a dollar for dollar expense just like any other business expense, regardless of the entity type (i.e. Sole proprietor, LLC). Does the fact that I am a sole proprietor have any bearing on my ability to claim a deduction for a profit sharing contribution? I realize self employment tax is calculated based upon net income, but profit sharing contributions are certainly tax deductible if you are an LLC or any other type of business organization. @dmertz 

[wes6]

@dmertz  Self-employment tax is calculated based upon net income, and other expenses such as fuel for my business vehicle (a deduction) lower net income for self-employment tax purposes. Elective deferrals also lower my net income. Why would a profit sharing contribution not lower my net income for self-employment tax calculation purposes? The contribution is exactly the same as the elective deferral in the sense that both contributions are taxed the same way upon distribution in retirement. I'm trying to wrap my head around why the profit sharing portion is treated any differently. 

[dmertz · Accepted solution]

A self-employed retirement deduction is a personal, above-the-line deduction, not a deductible business expense.  Only retirement contributions for non-owner employees constitute a business expense.  Because self-employed retirement contributions (for yourself) do not lower your net profit, they do not lower your self-employment taxes.

I assume that you have sufficient net profit to cover the deductible portion of self-employment taxes and the total of your self-employed retirement deduction since you said that adding the profit-sharing contribution changed the tax liability your state income tax return.

Another possibility on your federal tax return is that you have non-refundable tax credits such as a Retirement Savings Contributions Credit and your income tax liability (Form 1040 line 22) is already zero without the profit sharing contribution, meaning that even without the profit-sharing contribution your tax liability already consists only of "other" taxes such as self-employment tax that are not reduced by any retirement contributions.

[wes6]

@dmertz This was very helpful thank you for the explanation. 

[CharlesX]

I played the number with my year 2020 return since I plan to contribute profit-sharing contribution in 2021. Line 22 on my 1040 is not zero. But my federal and state tax numbers do not change at all after put contribution amount.  I read other articles, is the profit-sharing contribution unsupported calculation? How to deal it?