Earned Income Percentage Conversion Chart
Rev. 08/21/09; E-mail Alert 2009-13

Amazingly 25 years ago, in 1984, TEFRA (The Tax Equity and Fiscal Responsibility Act) brought a change in the calculation of a contribution for a self-employed. This is a complicated calculation. One part of the calculation involves using the definition of earned income instead of the net profits from Schedule C (or from the K-1 for a partner). For a self-employed individual the definition of earned income includes it having been reduced by the amount being contributed to the qualified plan for the self-employed. To do this, an algebraic formula must be used. This formula is the self-employed's contribution percentage divided by one plus the self-employed's contribution percentage or, where C = the self-employed's contribution rate:

The formula is  C%/(1+C%)

Example: If 15% is the contribution rate, then the formula would be .15/1.15 = .13043 or 13.043%. For illustrative purposes* lets say that this 13.043% would then be applied to the self-employed's net profits to obtain the contribution which would equal 15% of the earned income. Rather than go through the algebraic formula for each different percentage, the chart below presents the conversion of the contribution rate percentage to the algebraic equivalent to be used for the self-employed.

* Of course, half of the self-employment tax must also be subtracted from the net profit. That and other detailed steps in the calculation, such as if there are additional plans or additional employees are addressed in our Back-to-Basics eSeminar Series.

Bill Grossman, ERPA, QPA