The following deals with my response to a question about whether a
self-employed person whose earnings are eligible for the foreign
earned income exclusion is also permitted to make a deductible
contribution to a 401(k) plan. For those who don't have an interest in
reading all of the details below, it is my opinion that the law is
sufficiently vague so that the IRS could deny a deduction. But I have
no opinion as to whether the taxpayer would prevail if the IRS denied
the deduction and the taxpayer pursued the matter in court. Vern

QUESTION: For the Roth IRA, the IRS regs clearly state that one needs
taxable compensation to make a contribution (although I do pay self
employment tax!). However, in regards to the Roth Solo 401K (which
were created in 2006) all the regulations I could find only mention
compensation, nothing about taxable compensation, in regards to
defining contribution limits. I found a couple of websites with
opinions that there was nothing in the IRS regulations which would
prohibit a contribution which did not exceed my compensation
(regardless of taxable compensation). A $150/hour tax accountant
researched the issue and her opinion was also that I could contribute
as well. I could find no opinion or IRS regulation suggesting such a
contribution would not be allowed. Can you provide any specific IRS
regulation that speaks to the opinion you provide. I respect your
opinion a lot from all I have read (including publications purchased),
but was surprised your opinion was contrary to everything else I have
read and other opinions received (even if not contrary to what
intuition might say).

REPLY: My response was based on how I think the IRS might respond and
not because of any specific tax code sections or IRS regulations or
other authority. If you have opinions from specialists in the area of
qualified plans, they should know a lot more about this issue than I
do. I do not spend any of my time delving into the over-lapping and
obscure rules that apply to qualified retirement savings plans. My
previous response was simply an assessment of how I feel the IRS is
likely to respond to the issue. However, I did receive a reply from
another CPA who took issue with my reply. Here are his comments. And
by the way. We have exchanged a number of emails about obscure tax
issues (mostly international) and I have developed a very high respect
for his opinions. And please note that at the very end of this long
collection of comments, he agrees with my view that the law is unclear
and that the opinion of a specialist in this area should be sought.

From Tom Spott (First response):

Vern, I don't think the same rules apply here for a qualified plan.
Many US employees work abroad and are paid by US employers who are
funding qualified plans for them. The 401(k) is a contributory
qualified plan.

These rules clearly apply for an IRA.

But a qualified plan is different. Furthermore, remember that IRC Sec
911 does not treat pension distributions from foreign earned income as
foreign earned income for the 911 exclusion. This further implies to
me that the contributions to a qualified plan are not deductions
directly attributable to foreign earned income. The contributions are
mere deferral mechanisms (i.e. a timing difference) and the 911
exclusion is a permanent difference.

The last time I looked at this issue the situation was muddy at best.

Thomas J Spott

Spott, Lucey & Wall, Inc. CPA's
voice: 415-217-6901 fax: 415-217-6908
web page: www.SpottLuceyWall-CPAs.com
email: Thomas.Spott@...

Here is my reply to Tom followed by his comments:

Tom:

Your comments are highly appreciated. But in this case, are we talking
abut apples and oranges? I agree with respect to an employer
contribution to a 401(k) for an employee, because that affects the tax
deductions of the employer, even if the employee's earnings are exempt
due to the FEIE.

But the question below was about a self-employed solo 401(k)
contribution -- which I believe is subject to the earnings test the
same as a deductible IRA or self-employed SEP type of plan.

On the other hand, the questioner indicated that the plan was a "Roth
401(k)" -- which is a type of plan that I haven't heard of before. The
implication of a "Roth" type of plan is that it's not deductible but
that the earnings are tax free.

The whole subject of qualified plans is a mess and it's nearly
impossible for a non-specialist to keep up with all the different
rules for different plans. But I wonder if your comments were based on
the treatment of contributions to a plan by an employer rather than by
a solo self-employed person.

Vern

Here is Tom's Response -- which is fairly detailed and includes a
number of citations.

Vern (Second response):

Again, I have not researched this lately - my comments were spinning on
the IRA/Qualified plan distinction. An IRA is not a qualified plan
under IRC Sec 401. The rulings I recalled where the amount subject to
contribution had to exceed the 911 exclusion were directed to IRA's.

See: Reg. 1.403(b)-2 definitions:

(11) Includible compensation means the employee's compensation received
from an eligible employer that is includible in the participant's
gross income for Federal income tax purposes (computed without regard
to section 911) for the most recent period that is a year of service.
Includible compensation for a minister who is self-employed means the
minister's earned income as defined in section 401(c)(2) (computed
without regard to section 911) for the most recent period that is a
year of service. Includible compensation does not include any
compensation received during a period when the employer is not an
eligible employer. Includible compensation also includes any elective
deferral or other amount contributed or deferred by the eligible
employer at the election of the employee that would be includible in
the gross income of the employee but for the rules of sections 125,
132(f)(4), 402(e)(2), 402(h)(1)(B), 402(k), or 457(b). The amount of
includible compensation is determined without regard to any community
property laws. See section 415(c)(3)(A) through (D) for additional
rules, and see §1.403(b)-4(d) for a special rule regarding former
employees.

But then see:

Federal Tax - CCH Explanations and Analysis - Standard Federal Income
Tax Reporter - Deferred compensation --Secs. 401-436 - Qualified plans
--Sec. 401 - CCH-ANNO, Definitions and General Rules Relating to
Self-Employed Persons - CCH-ANNO, Earned Income -

CCH-ANNO, 2008FED ¶17,933.65 Definitions and General Rules Relating to
Self-Employed Persons: Earned Income: Foreign income

Definitions and General Rules Relating to Self-Employed Persons: Earned
Income: Foreign income

Where an owner-employee has net earnings that are excludable as foreign
earned income (Code Sec. 911), such excluded net earnings do not
constitute earned income for purposes of computing contributions on his
behalf to a self-employed plan. Rev. Rul. 70-491, 1970-2 CB 92.

NON: FED01 P17933.65:
http://tax.cchgroup.com/network&JA=LK&fNoSplash=Y&&LKQ=GUID%3A96f75b53-1c96-3079\
-91d0-21cd71fef625&KT=L&fNoLFN=TRUE&
FED01 #24642 [FEDCP 99FED ]

© 2008, CCH INCORPORATED. All Rights Reserved.
Find help at http://support.cch.com, call Research Specialists at
800-344-3734, | Back to Top
or call Tech Support at 800-835-0105.

I do think that Rev Rul 70-491 is out of whack primarily because it was
1970 rules when the $25,000 exclusion was in effect and distributions
from pensions during foreign assignments were foreign earned income for
911.

Having said that there is a blurry line here vis-à-vis single member
401(k)'s and Roth 401(k)'s due to all the laws that have passed.

I agree about the confusion in pension plans - I always recommend
clients seek out a pro to make a choice.

Tom

The comments in this memorandum are not intended to constitute an
opinion regarding any specific tax issues because additional tax
issues may exist that could affect the tax treatment of the tax issues
addressed in this memo. This memorandum does not consider or reach a
conclusion with respect to those additional issues and was not written
and cannot be used for the purpose of avoiding penalties under code
section 6662(d). For further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm