How much of a federally allowed qualified-retirement-plan contribution could a nonresident partner deduct on a California return when the partnership earned income inside and outside California?

Plain-English summary

California Legal Ruling 431 limited a nonresident partner's qualified-retirement-plan deduction to the portion attributable to earned income from California sources.

The deduction was computed on the individual's return rather than at the partnership level. But because the deduction was closely connected to the earned income supporting the contribution, FTB apportioned the allowable federal deduction using a California earned-income ratio.

The ruling's formula was:

California-source earned income ÷ total earned income supporting the contribution × allowable federal deduction

The remainder of the federal deduction was added back on the nonresident California return.

Why the deduction was apportioned

California residents were taxed on income from all sources, so the ruling said a full-year resident's federal and California deductions for qualified-plan contributions generally should match.

A nonresident, however, was taxed only on California-source income. Section 17301 directed FTB to prescribe rules for allocating deductions connected with income inside and outside California.

Although the retirement-plan deduction was taken by the individual outside the partnership computation, FTB found it intimately connected to the earned income on which it was based. The ruling therefore used concepts similar to the partnership's California income apportionment to source the deduction.

The ruling's numerical example

A was a nonresident partner in a personal-service partnership operating inside and outside California.

• A's share of that partnership's total income was $300,000.
• A's California-source share from that partnership was $100,000.
• A also had $25,000 of self-employment income from another partnership in which A was only a passive investor.
• The personal-service partnership contributed $15,000 to a defined-contribution Keogh plan for A, and the full $15,000 was allowed federally.

The ruling used $300,000 as the total earned income supporting the contribution and calculated:

1. $100,000 ÷ $300,000 = 33%.
2. 33% × $15,000 = $5,000 California deduction.
3. $15,000 federal deduction − $5,000 California deduction = $10,000 California addback.

The ruling directed that the $10,000 addition be detailed on Schedule SI and carried to the 1987 Form 540NR.

Individual deduction, not partnership deduction

FTB emphasized that a qualified-plan contribution for a self-employed partner was an individual deduction, even though the partnership reported it on Schedule K-1.

It also noted that federal contribution limits applied in the aggregate when a self-employed individual had earned income supporting deductions from two or more employers.

Historical group-return result

The ruling described a then-existing California group-return election for partnerships with qualifying nonresident partners. Under that statute, no deductions were allowed except those necessary to determine each partner's distributive share.

Because the retirement-plan deduction was computed separately from distributive share, a partner included in that group return could not claim the deduction described in the ruling.

What this means for you

Nonresident partners

Under the ruling's historical method, a full federal retirement-plan deduction did not automatically produce a full California deduction. The deduction followed the California-source share of the earned income supporting it.

Partnerships

The partnership reported the contribution as a separately stated item, but the partner calculated the California deduction at the individual-return level.

Accountants and tax professionals

Identify which earned income supported the contribution, source that income to California, and distinguish individual-return deductions from distributive-share items. Use current forms and group-return rules rather than the 1987 lines named in the ruling.

Common questions

Q: Was the California deduction always the same as the federal deduction?

A: For the nonresident addressed here, no. Only the California-source portion was deductible.

Q: What ratio did FTB use?

A: California-source earned income divided by total earned income supporting the contribution.

Q: Why was the allowable California amount $5,000?

A: The $100,000 California amount was one-third of the $300,000 total, and one-third of the $15,000 federal deduction was $5,000.

Q: What happened to the other $10,000?

A: It was a California addition because that portion of the federal deduction was not attributable to California-source earned income.

Q: Could the deduction be taken on the historical group return?

A: No. The ruling said the group return allowed only deductions necessary to determine distributive share, while this deduction was computed separately.

Citations and references

• Cal. Rev. & Tax. Code §§ 17041, 17301, 17501, 17951-17954, 18408.5, and 25120-25139
• I.R.C. §§ 401(c)(2), 404, 415, and 702(a)(8)
• 18 Cal. Code Regs. §§ 17951-4(e)-(h)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 431

Original ruling text

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Legal ruling 431

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division

November 02, 1988

Qualified Plan Contributions - NonResident Partner

Advice has been requested as to the proper method of computing the allowable deduction to be claimed on a nonresident individual tax return (Form 540NR) for partnership contributions to a qualified retirement plan made on behalf of a nonresident partner in a personal service partnership which derives income from both within and without California.

For the reasons set forth below, the allowable deduction is limited to that portion of the allowable federal deduction attributable to earned income from California sources.

Internal Revenue Code §§ 415(a)-(c) and 404 provide limitations on the deductibility of contributions to retirement plans made on behalf of self-employed individuals.

For years beginning on or after January 1, 1987, the Revenue and Taxation Code has incorporated by reference the above-cited provisions of the Internal Revenue Code. ( See § 17501; see also § 17503, as repealed by Assembly Bill 53, Stats. 1987, Ch. 1138.)

Thus, in the case of a full-year resident of California taxed on income from whatever source derived (§ 17041 (a)), the amount of allowable federal and California deduction for retirement plan contributions made on behalf of self-employed partners should be the same.

However, it must be kept in mind that the deduction for contributions to a qualified retirement plan on behalf of a self-employed partner is an individual and not a partnership deduction, and is deducted outside the partnership context. This deduction is reflected on line 11, Schedule K-1, and is to be transferred to page 1 of the individual’s personal income tax return.

Further, if a self-employed individual receives earned income with respect to which deductions would be allowed from two or more employers, the deduction limitations apply in the aggregate (Internal Revenue Code § 415).

A nonresident may only be taxed upon income derived from California sources (§ 17041(b)).

In the case of a nonresident, the proper apportionment and allocation of deductions with respect to sources of income within and without California is to be determined under rules and regulations prescribed by the Franchise Tax Board (§ 17301).

If a trade or business such as a professional partnership is carried on within and without California, its income derived from California sources must be determined in accordance with the provisions of the Uniform Division of Income for Tax Purposes Act as adopted in §§ 25120-25139 (Cal. Code Regs., tit. 18, Reg. §§ 17951-4(e) - (h)).

The deduction under consideration is intimately connected to the earned income upon which the deduction is based. Therefore, even though the deduction is computed at the individual level outside the partnership context, it is appropriate to apply concepts similar to those which apportion income and deductions within and without California in order to apportion the deduction properly, even though the Uniform Division of Income for Tax Purposes Act, supra, is not directly applicable.

Because of this relationship, taking into account the factors discussed above, it is our opinion that the deduction under consideration should be sourced in California to the same extent as the income upon which it is based. The appropriate method of accomplishing this goal is to apportion the federal deduction based upon the ratio of earned income sourced in California to total earned income.

The following example is illustrative:

A, a single nonresident individual, is a partner in a personal service partnership which does business within and without California and which reports on a calendar year. A's share of partnership income from this personal service partnership is $300,000. A also has $25,000 of self-employment income within the meaning of Internal Revenue Code § 401(c)(2) received from a general partnership in which A is a passive investor only.

For 1987, A's share of partnership income from all sources is $325,000. Under §§ 17951-17954, A's share of partnership income from the personal service partnership attributable to California sources is $100,000.

For federal income tax purposes, a partnership contribution is made on behalf of A to a defined contribution Keogh plan in the amount of $15,000, and is properly reflected by the partnership on A's K-1 ( see Internal Revenue Code § 702(a)(8).

A files a nonresident California income tax return (Form 540 NR).

A's California adjustment for the contribution to the Keogh plan made on his behalf is computed as follows:

Ratio of earned income sourced in California/total earned income used to support the contribution: $100,000/$300,000 = 33%.

Ratio in a. above applied to the allowable federal deduction: 33% of $15,000 = $5,000.

Federal deduction (deducted in computing federal adjusted gross income) less the amount in b. above: $15,000 - $5,000 = $10,000 California adjustment.

This amount should be treated as an addition to be shown and detailed on Schedule SI (California Source Income) and carried over to page 1 of Form 540 NR.

It is also noted that, under § 18408.5 (Assembly Bill 129, Stats. 1987, Ch. 918), a partnership doing business or deriving income from California sources may elect to file a single group return on behalf of its nonresident partners. The return may only include partners having no other income derived from California sources. The tax on each electing partner’s distributive share is the highest marginal rate provided for individual income taxpayers, and no deductions shall be allowed except those necessary to determine each partner’s distributive share.

Because the deduction discussed herein is computed independently of the computation of the individual partners' distributive shares, if a partnership elects the provisions of § 18408.5, no deduction may be claimed by the individual partners for contributions made on their behalf to qualified retirement plans.

Last updated: 09/24/2025