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Understanding K-1 Income in Retirement Plan Design

What is K-1 Compensation? Owners of partnerships and LLCs taxed as partnerships typically receive income reported on a K-1, rather than wages reported on Form W-2. This means that unlike employees, these owners do not receive traditional salaries with FICA withholding; instead, they receive “earned income,” which is derived from their distributive share of profits and guaranteed payments for services. S-corporation shareholders might also receive K-1 income, in addition to W-2 wages.

As advisors, it is important to understand that not all K-1 income counts as plan compensation. For partners, plan compensation is “earned income,” i.e., net earnings from self-employment, which is generally the partner’s share of the trade or business income and guaranteed payments for services to the extent they are subject to self-employment taxes. Passive income, investment returns, or distributions not tied to related services are generally excluded. 

Why it Matters for Retirement Plans: Contribution limits, nondiscrimination testing, and plan allocations all depend on clear and correct definitions of plan compensation. For example:

• Partnerships and LLCs: Contributions for partners are based on earned income after deducting plan contributions and one-half of self-employment taxes.
• S-corporations: Only W-2 wages count as plan compensation; K-1 distributions to shareholders do not.
• Guaranteed Payments: Guaranteed payments for services generally qualify as plan compensation.

Failing to distinguish between eligible K-1 income and other partnership allocations can inflate or understate allowable contributions, and result in issues for plan sponsors.

Key Takeaways for Plan Advisors: For business owners with K-1 income, understanding plan compensation is not always straightforward. As plan advisors, you can assist your clients by identifying the type of entity they own, clarifying the nature of their K-1 income, and ensuring plan documents clearly define compensation. Be sure to coordinate with your TPA and CPA partners to ensure plan compliance, crosscheck calculations and make any necessary tax adjustments.

Reminders:

• October 15, 2025: For calendar-year plans, deadline to adopt and implement a corrective amendment to correct a Code Section 410(b) coverage failure or a Code Section 401(a)(4) nondiscrimination failure for the 2024 plan year.
• October 15, 2025: Deadline to file Form 5500 (plan years ended December 31), for those plans that previously filed a Form 5558 extension request.

Jesse St. Cyr, Partner, Poyner Spruill
Jesse is a member of the Employee Benefits and Executive Compensation team at Poyner Spruill LLP. He represents clients before the IRS and DOL in matters involving employee benefits. Jesse has experience working with a diverse range of benefits and compensation matters and has extensive experience working with a variety of employers. Jesse is recognized by Chambers USA as a leading lawyer for Business (Employee Benefits & Executive Compensation).