Cash balance plans are one of the little know retirement secrets. But do they work in a partnership tax structure?
In this article, we will discuss how to structure a cash balance plan for a partnership that files form 1065. We’ll point out a few of the differences and give you some tax filing tips. Let’s jump in.
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Cash Balance Plan for Partnership
The term “partnership” is used to refer to any entity that is flow-through for federal and state tax purposes. It will file form 1065.
In general, partnership taxation consists of setting aside funds that will be used to pay taxes on the partnership’s profits. This money is divided by ownership shares to determine what percentage of each owner’s income will be taxed.
During the year, partners should estimate the amount of tax they’ll owe and make quarterly payments to the IRS or state tax agency. You can even use the same method as an individual if you’re just a single owner, as long as you don’t exceed the tax threshold.
So, when it comes time to distribute the profits, consult a tax professional. It’s important to note that some tax laws have special rules regarding distributions of profits.
Partnerships can be comprised of individuals, estates, trusts, corporations, or associations. In general, the total capital invested in a partnership equals the total net asset value minus any liabilities.
Many SME (small or medium-sized enterprise) owners choose cash balance plans because they provide options not available under other employer-sponsored retirement plans. But what is a cash balance plan (CBP)? And how can it save you from handing over your hard-earned money to the government in taxes while supercharging your retirement account?
Deducting Contributions on a Partnership (1065) Tax Return
Partnership tax returns are a little more complex than other types of tax returns. This is thanks to pass-through taxation and the flexibility of how income and specific expenses can be allocated to the various partners.
Like an S-Corp tax return, a partnership return will generate a Form K-1. The K-1 has all the data relating to the income allocated to the partners and the cash balance plan contribution amount.
Form K-1: Line 1
The initial step is to examine box 1 of the K-1. This is the ordinary income allocated to the partner. Take a look below:
This is the first step. The amount in box 1 is $125,000. This is the profit allocation, but it does NOT reflect any cash balance plan contribution.
Form K-1: Line 14
Remember that just because there is an allocation in box 1, it does not mean that the partner is even allowed to have a retirement contribution. The partner must be active in the business to get the retirement allocation. There must be active participation.
Take a look at box 14 of the K-1 (bottom left portion). This is where you would include self-employment earnings. Examine the K-1 in the image below:
Notice that the amount in box 1 equals the amount in box 14. This is typical for active partners who are eligible for a retirement contribution. The amount in box 14 is what the actuary would use to determine the required contribution for the year.
Form K-1: Line 13 – Code R
For example, assume that a target contribution is $50,000 for a given partner, and the partnership contributed this amount. How is this reflected on the 1065 tax return?
Cash balance plan contributions are classified under the qualified plan category. As such, they are reflected on line 13: Code R. Below is what the IRS has to say:
It will then look like the following:
Remember that we have focused on how the contribution is recorded on the K-1. But the cash balance plan contribution will also be recorded on page 4 of form 1065. It is included in the K-1 section on line 13. The entire amount is entered in this section and allocated to the partners on line 13: Code R of the form K-1.
Cash Balance Plan for Partnership Rules
How to follow the cash balance plan rules:
- Hire a qualified TPA. Many TPAs don’t have a lot of experience with cash balance plans. A good TPA can go a long way to keeping you out of trouble.
- Make sure you do applicable restatements. Plans must be periodically restated to stay compliant. Your TPA will typically instigate the restatement.
- File Form 5500. The IRS requires form 5500 to be filed for most cash balance plans with assets over $250,000. But remember, this requirement is also applicable when assets of combo plans cumulatively exceed $250,000.
- Process plan amendments before the deadline. Remember to reduce annual contributions before participants become eligible with a plan amendment. You can always do a plan amendment to increase benefit contributions.
First, discuss your situation with your CPA or tax preparer. Once you are ready, find a qualified third-party administrator (TPA) who can set up the plan for you.
Once the plan is established, you will need to decide on a custodian who will maintain your brokerage account. Then write the check!