a client has been making contributions to his Money Purchase plan but does not have compensation to justify the contributions. He has K1 income and thus is not entitled to make contributions to the MP Plan. What should he do to remedy the situation? Is this handled like a typical "non-deductible contribution." Are these contributions subject to the plan asset rule?

Is this an S corporation and that is why he has K-1 income, but not compensation?

yes it is an S-Corp.

Well - we have had experience on this issue in 2 ways. First, it is pretty clear that K-1 income is not earned income in the same context as a partnership. Thus, as you noted, it is not eligible for the plan.

However, we have also had payroll tax audits where the government has come in and reclassified some payments as wages on the basis that the individual is understating their obligation for FICA tax, etc. by failing to pay a wage.

I am not sure that you can get by with the "mistake of fact" because it is a mistake of law, not fact. But that is just my opinion. Others are likely to disagree. So, you need to look at what options are in the plan.

I just love it when the too, too clever tax avoiders find out that they are not so clever after all. The taxpayer has some tough choices to make about getting everything straight and needs comprehensive advice about all aspects of the games being played. Depending on the global position eventually taken, the position of the plan should be conformed to the extent possible. Anticipate correction of an operational error under the plan.