Where does the Retirement Plan Contribution SEP-IRA or Profit Sharing Plan get deducted by Self-Employed person?

Self-employed worker could only take pension plan deduction on Form 1040, not on Schedule C

LaFlamme, TC Memo 2012-36

The Tax Court has held that a self-employed real estate agent was entitled to deduct her pension plan contribution on Form 1040 when calculating her income tax liability, but not on Schedule C when calculating her self-employment tax liability.

Facts. Lisa LaFlamme was a self-employed real estate agent who in 2006, contributed $34,400 to the Lisa K. LaFlamme Defined Benefit Pension Plan and Trust. LaFlamme claimed a deduction for the pension contribution on line 19 (Pension and profit sharing plans) of the Schedule C (Profit or Loss from Business) she attached to her Form 1040 (U.S. Individual Income Tax Return) for 2006. She did not claim a deduction for the pension contribution on line 28 (Self-employed SEP, SIMPLE, and qualified plans) of her Form 1040. IRS issued a notice of deficiency disallowing the pension contribution deduction that LaFlamme had claimed on Schedule C, but allowing her to deduct the pension contribution on line 28 of Form 1040.

Background. As the Tax Court noted, the self-employment tax imposed by chapter 2 (Tax on Self-Employment Income) of subtitle A of the Code is distinct from the income tax imposed by chapter 1 (Normal Taxes and Surtaxes). When a taxpayer deducts an expense on Schedule C, the deduction reduces net earnings from self-employment, thereby reducing self-employment tax liability. The deductions on Schedule C also reduce the taxpayer’s income tax liability by lowering the business income included in gross income.

Before ’62, self-employed taxpayers were not considered to be their own employers and employees, and the contributions they made to their pension plans were not business expenses. Thus, self-employed taxpayers were unable to deduct the contributions they made to their pension plans. But then Congress enacted the Self-Employed Individuals Tax Retirement Act of ’62 (’62 Act), P.L. 87-792, to allow self-employed taxpayers to deduct from gross income the contributions they made to their pension plans.

To allow the deduction, the ’62 Act, Sec. 3, provided that a self-employed individual is considered to be her own employer and her own employee; and that contributions made by a self-employed taxpayer to a pension plan “shall be considered to satisfy the conditions of” Code Sec. 162 or Code Sec. 212. Further, the ’62 Act, Sec. 7, amended Code Sec. 62 to provide that self-employed individuals were entitled to the deduction from gross income allowed by Code Sec. 404 (relating to employer deductions for contributions to retirement plans). (Code Sec. 62(a)(6)) Thus, for purposes of calculating income tax liability, a taxpayer (such as LaFlamme) was entitled to deduct the pension contribution from her gross income (as IRS had conceded).

The Code Sec. 1401 rules impose a tax on the “self-employment income” of every individual. Self-employment income is generally defined as the net earnings from self-employment derived by an individual. The term “net earnings from self-employment” is defined as the gross income derived by an individual from any trade or business carried on by the individual, less deductions otherwise allowed which are attributable to that trade or business.

Court’s conclusion. The Tax Court reasoned that for purposes of determining her self-employment tax, LaFlamme could deduct the amount of the pension contribution only if the pension contribution was (1) a deduction allowed by subtitle A (Income Taxes) of the Code, and (2) attributable to her trade or business. As Subtitle A allowed LaFlamme a deduction for the pension contribution, she could deduct the pension contribution when computing self-employment tax liability if the contribution were indeed attributable to her trade or business.

LaFlamme argued that she was entitled to deduct the pension contribution on Schedule C because the ’62 Act treats a pension contribution as a business expense satisfying Code Sec. 162 for the purpose of computing income tax liability under chapter 1, so the contribution also should be treated as a business expense for the purpose of computing self-employment tax liability under chapter 2.

The Tax Court wasn’t persuaded. Deductions are a matter of legislative grace, and are to be construed narrowly. Further, taxpayers bear the burden of proving their entitlement to deductions. Except for the special rule in Code Sec. 404(a)(8)—which allows contributions to qualified plans covering self-employed individuals to be deductible under the Code Sec. 404 rules applicable to employer contributions to qualified plans—a self-employed taxpayer’s contribution is not an expense attributable to the taxpayer’s trade or business. LaFlamme failed to point to any authority, and the Court said it discovered none, providing that the special rule in Code Sec. 404(a)(8) applies outside the context of Code Sec. 404. Thus, the court held, LaFlamme’s pension contribution wasn’t attributable to her trade or business, and not deductible on her Schedule C.

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