2010 Health-insurance and IRA/qualified plan contributions

Jul 10, 2011 2 Replies
S

I am wondering if anyone can provide a clear explanation of the interaction between the adjustement to income for self-employed health insurance, and the allowed maximum contribution to qualified plans. It seems this has possibly changed in 2010 due to the change in self-employment tax on health insurance, but the instructions are less than unambiguous.



Here is what it says in Pub 560 (left hand side of page 5) regarding computing net earnings from Self-Employment:



"When calculating the deduction for one-half of self-employment tax, the deduction for self-employed health insurance is disregarded".



And the following statement is in the instructions for 2010 form 5329:



"For IRA purposes, earned income does not include any self-employed health insurance deduction you used in figuring the amount to enter on Schedule SE, line 3."



I *think* (but am by no means certain) what this all means is one calculates what the SE tax would have been without the 2010 rule change (i.e. one ignores the amount paid for health insurance), and uses half of this value (rather than half of the actual SE tax value) when computing the adjusted income from self-employment.



Or in other words, the lower self-employement tax under the 2010 rules does not add to the allowable plan contribution.



I also believe the above statement "For IRA purposes" is confusing because the same rules apply to both IRA's and qualified plans. Am I correct on this?



Thanks, Steve


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A

This is what I understand and my software uses: For 2010 only, you compute SE tax after you subtract your health insurance adjustment on Line 29 of the F1040 from your net profit (the sum of lines 1a, 1b and 2 on the F1040-SSE).

For determining the amount of earnings in order to contribute to an IRA, you subtract from your net profit as identified above, the amounts on Line 27 (1/2 SE Tax) and Line 28 (Retirement Plan Contributions) of the F1040.

I believe that the confusion about the health insurance deduction in

2010 is driven by the fact that the IRS elected not to include a line on the Form 1040-SSE for the deduction. Line 3 was always the net profit. For 2010, Line 3 would no longer represent net profit if you deducted health insurance. To get to net profit, you would have to add back the health insurance deduction.
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S

Thanks.

Since I wrote the above, I heard back from my EA, who has run some experimental cases through Lacerte. It seems what I first guessed above is (by that experiment) correct: the health insurance amount does not affect the plan contribution amount. So line 27 on the 1040 is no longer the correct amount (in all cases) to subtract from the Schedule C profit for the purpose of computing plan contribution levels.

This seems consistent with the vaguely worded instructions I quoted above.

If one were to be tripped up by this, one would probably make too large a contribution to the plan, although not by a gigantic amount.

Steve

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