We got this question from a reader today:
“Can the amount I contribute to my solo 401k as deferred compensation be used as wages when figuring the domestic production activities deduction? I have no other wages.”
Several years ago Congress placed into law a Domestic Production Activities Deduction (DPAD) that was primarily in response to the World Trade Organization disallowing some of our other tax incentives. As a result, farmers are entitled to deduct approximately 9% of their net farm income as long as they meet certain other rules. One of the rules limits the deduction to 50% of W2 wages.
If the farmer is sole proprietor and has no employees, then the only DPAD deduction available is if they have a flow-through DPAD deduction from a cooperative.
In the case of our reader, since he has no employees wages and the solo 401k is not considered wages, then no DPAD deduction is available.
This is a case where it may make sense to pay your spouse a wage to take advantage of the DPAD deduction and in many cases it will allow you to deduct more 401k expense. The offset is that payroll taxes will be owed on the wages to your spouse and that cost may outweigh the deduction benefit.
Paul Neiffer, CPA