The Deductible Retirement Plan Contribution is NOT to be confused with the maximum allocation permissible to any one individual in a qualified retirement plan.
Employer contributions to defined contribution plans (like 401(k) / profit sharing plans) are indeed limited to an employer deduction of 25% of total eligible compensation. For this purpose, “eligible compensation” is restricted to compensation paid to employees who are receiving the employer contribution. However, one more of those employees may actually receive contributions far in excess of 25% of their compensation. Essentially the highly rewarded individual(s), usually the business owner(s), is leveraging off of the lower employee contribution rates.
The maximum allocation permissible to any one individual is the lesser of 100% of compensation or $53,000 (for 2015). This maximum allocation amount includes both employer and employee (401(k) elective deferral) contributions. It does not, however, include 401(k) elective deferral “catch-up” contributions made by those of us who are 50 or older.
For a sole proprietor that has employees and receives such a favorable allocation of the employer contribution, the tax preparation software may erroneously flag the deduction as impermissible. After all, the system just doesn’t have all of the facts it needs to perform the computation. As my wise mentor once suggested to me, the software is to be used as a tool; YOU are to be the expert!