A sole proprietor has average compensation for 3 years of 200K and in the fourth year has comp of 50K. The funding obligation for a DB Plan is 80K. I believe that Code Section 404(a)(8) provides a deduction limit of 50K in this situation, but what happens to the extra 30K? Does the deduction carry forward or is it a non-deductible contribution that won't be taxed upon retirement?

First, the 50k must first be reduced for 1/2 of the self-employment taxes. The net figure is what the sole proprietor can deduct. This is exactly why final average pay plans with sole proprietors are either a bad idea or must be monitored closely.

Next, this situation will be like any other non-deductible contribution. It will reduce the 404 assets for future valuations until it is no longer there. You may never be able to get it removed, as often times the maximum deductible contribution is not greater than the minimum contribution, but if it is, then you are in business.

For example if next year's numbers look like this:

Minimum contribution: 20,000
Maximum deductible contribution: 40,000

You can fund the 20,000, deduct the 40,000 and reduce your non-deductible in the plan.

Good news is there is no excise tax for this situation where the contribution is nondeductible simply because the sole proprietor does not have enough income.