As 2018 comes to an end, it is critical that Solo 401(k) owners understand when and how to make their 2018 contributions. There are three important deadlines you must know if you have a Solo 401(k) or if you plan to set one up still in 2018. A Solo 401(k) is a retirement plan for small business owners or self-employed persons who have no other full time employees other than owners and spouses. It’s a great plan that can be self-directed into real estate, LLCs, or other alternative investments, and allows the owner/participants to contribute up to $55,000 per year (far faster than any IRA).
New Solo 401(k) Set-Up Deadline is 12/31/18
First, in order to make 2018 contributions, the Solo 401(k) must be adopted by your business by December 31st, 2018. If you haven’t already adopted a Solo 401(k) plan, you should start now so that documents can be completed and filed in time. If the 401(k) is established on January 1st, 2019 or later, you cannot make 2018 contributions.
2018 Contributions Can Be Made in 2019
Both employee and employer contributions can be made up until the company’s tax return deadline including extensions. If you have a sole proprietorship (e.g. single member LLC or schedule C income) or C-Corporation, then the company tax return deadline is April 15th, 2018. If you have an S-Corporation or partnership LLC, the deadline for 2018 contributions is March 15th, 2019. Both of these deadlines (March 15th and April 15th) to make 2018 contributions may be extended another six months by filing an extension. This a huge benefit for those that want to make 2018 contributions, but won’t have funds until later in the year to do so.
W-2’s Force You to Plan Now
While employee and employer contributions may be extended until the company tax return deadline, you will typically need to file a W-2 for your wages (e.g. an S-Corporation) by January 31st, 2019. The W-2 will include your wage income and any deduction for employee retirement plan contributions will be reduced on the W-2 in box 12. As a result, you should make your employee contributions (up to $18,500 for 2018) by January 31st, 2019 or you should at least determine the amount you plan to contribute so that you can file an accurate W-2 by January 31st, 2019. If you don’t have all or a portion of the funds you plan to contribute available by the time your W-2 is due, you can set the amount you plan to contribute to the 401(k) as an employee contribution, and will then need to make said contribution by the tax return deadline (including extensions).
Now let’s bring this all together and take an example to outline how this may work. Sally is 44 years old and has an S-Corporation as an online business. She is the only owner and only employee, and had a Solo 401(k) established in 2018. She has $120,000 in net income for the year and will have taken $50,000 of that in wage income that will go on her W-2 for the year. That will leave $70,000 of profit that is taxable to her and that will come through to her personally via a K-1 from the business. Sally has not yet made any 2018 401(k) contributions, but plans to do so in order to reduce her taxable income for the year and to build a nest egg for retirement. If she decided to max-out her 2018 Solo 401(k) contributions, it would look like this:
- Employee Contributions – The 2018 maximum employee contribution is $18,500. This is dollar for dollar on wages so you can contribute $18,500 as long as you have made $18,500. Since Sally has $50,000 in wages from her S-Corp, she can easily make an $18,500 employee contribution. Let’s say that Sally doesn’t have the $18,500 to contribute, but will have it available by the tax return deadline (including extensions). What Sally will need to do is let her accountant or payroll company know what she plans to contribute as an employee contribution so that they can properly report the contributions on her payroll and W-2 reporting. By making an $18,500 employee contribution, Sally has reduced her taxable income on her W-2 from $50,000 to $31,500. At even a 20% tax bracket for federal taxes and a 5% tax bracket for state taxes that comes to a tax savings of $4,625.
- Employer Contributions – The 2018 maximum employer contribution is 25% of wage compensation. For Sally: Up to a maximum employer contribution of $36,500. Since Sally has taken a W-2 wage of $50,000, the company may make an employer contribution of $12,500 (25% of $50,000). This contribution is an expense to the company and is included as an employee benefit expense on the S-Corporation’s tax return (form 1120S). In the stated example, Sally would’ve had $70,000 in net profit/income from the company before making the Solo 401(k) contribution. After making the employer matching contribution of $12,500 in this example, Sally would then only receive a K-1 and net income/profit from the S-Corporation of $57,500. Again, if she were in a 20% federal and a 5% state tax bracket, that would create a tax savings of $3,125. This employer contribution would need to be made by March 15th, 2019 (the company return deadline) or by September 15th, 2019 if the company were to file an extension.
In the end, Sally would have contributed and saved $31,000 for retirement ($18,500 employee contribution, $12,500 employer contribution). And she would have saved approximately $7,750 in federal and state taxes. That’s a win-win.
Keep in mind, you need to start making plans now and you want to begin coordinating with your accountant or payroll company as your yearly wage information on your W-2 (self employment income for sole props) is critical in determining what you can contribute to your Solo 401(k). Also, make certain you have the plan set-up in 2018 if you plan to make 2018 contributions. While IRAs can be established until April 15th, 2019 for 2018 contributions, a Solo K must be established by December 31st, 2018. Don’t get the two confused, and make sure you’ve got a plan for your specific business.
Note: If you’ve got a single member LLC taxed as a sole proprietorship, or just an old-fashioned sole prop, or even or an LLC taxed as a partnership (where you don’t have a W-2), then please refer to our prior article here on how to calculate your Solo K contributions as they differ slightly from the s-corp example above.
Late last week, the IRS announced increased contribution limits for IRAs, 401(k)s and other retirement plans. IRAs have been stuck at $5,500 since 2013, but are finally moving up to $6,000 starting in 2019. If you save in a 401(k), including a Solo K, the good news is that your contribution limits were increased too, with employee contributions increasing from $18,500 to $19,000 and total 401(k) contributions (employee and employer) reaching $56,000. The IRS announcement and additional details can be found here.
Health savings account (HSA) owners also won a small victory with individual contribution maximums increasing by $50 to $3,500, and family contribution amounts increasing by $100 to $7,000.
Here’s a quick breakdown on the changes:
- IRA contribution limitations (Roth and Traditional) increased from $5,500 to $6,000, and there is still the $1,000 catch-up amount for those 50 and older.
- 401(k) contributions also increased for employees and employers: Employee contribution limitations increased from $18,500 to $19,000 for 2019. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $55,000 to $56,000 ($62,000 for those 50 and older).
- HSA contribution limits increased from $3,450 for individuals and $6,900 for families to $3,500 for individuals and $7,000 for families.
These accounts provide advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, tax deferred growth, or tax-free income, you should be using one or all of these account types. Keep in mind there are qualifications and phase out rules that apply, so make sure you’re getting competent advice about which accounts should be set up in your specific situation. Lastly, remember, all of these accounts can be self-directed and invested into assets you know best.
Are you a U.S. citizen considering moving yourself or your money outside the USA? Before you or money leave the USA, first consider the tax and legal consequences as they are often misunderstood.
U.S. Citizens have numerous tax and reporting obligations that arise from their foreign assets, investments, and accounts. In essence, if you have foreign assets, investments, or bank accounts, then you have two obligations to the United States Government.
First, you must disclose any foreign bank account whose value is over $10,000 (all foreign accounts are combined to reach the $10,000 threshold) and you must report any foreign asset (e.g. foreign stock, company ownership, etc.) whose value is $50,000 or greater. The form required to be filed annually to disclose foreign bank accounts in excess of $10,000 is known as FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). The form filed annually to disclose foreign assets with a value in excess of $50,000, is IRS Form 8938, Statement of Specified Financial Assets. In sum, the first obligation U.S. citizens have to their home country is the disclosure of foreign bank accounts and foreign assets.
Second, as a U.S. citizen you are required to pay U.S. federal income tax on the foreign income you receive as the U.S. taxes its citizens on income no matter whether it was earned in the U.S. or abroad. In other words, even if you make money outside the U.S., as a U.S. citizen, you are still required to pay federal tax on that income. If you paid foreign income taxes to the country where the income was derived and if that country has a tax treaty with the U.S., then you’ll typically receive a credit in the U.S. for the foreign taxes paid, which thereby reduces the amount of federal taxes owed in the U.S. Click here to see the list of countries with a foreign tax treaty with the U.S.
Some U.S. citizens presume that if they leave the U.S. that they are no longer subject to federal income tax in the U.S., but this is not the case. Even if you relocate to a foreign country and no longer earn income from the U.S., you are still subject to U.S. tax on your foreign income (and potential state income tax depending on your state of residence). The only way to entirely escape the tax jurisdiction of the United States is to renounce U.S. citizenship but this is a costly and expensive process with numerous tax repercussions. See the Expatriation Tax rules from the IRS for more information here.
Let’s run through a common example that demonstrates how the disclosure and income tax reporting requirements work. A U.S. citizen has a bank account in Switzerland with a balance of $100,000. That account generates income of $5,000 for the year. For example purposes, let’s say that the $5,000 in income resulted in taxes owed to Switzerland of $500 and that the U.S. citizen reported and paid the tax to Switzerland.
- FBAR. In addition to compliance with Switzerland law, the U.S. citizen would need to file FinCEN Form 114 (FBAR) to disclose the foreign bank account. The FBAR form filing is due by April 15th for the prior year’s accounts. This was changed effective 2017 as the deadline used to be by June 30th for the prior year. A 6-month automatic extension has currently been offered.
- Statement of Foreign Asset. The U.S. Citizen would also need to file IRS Form 8938, since the account was over $50,000. Form 8938 is due with the filing of the U.S. citizen’s federal tax return.
- Foreign and U.S. Tax Reporting. In addition to the two disclosure forms that are filed in the U.S., the $5,000 of income from the Switzerland account must be reported as taxable income on the income tax return (form 1040) of the U.S. citizen. The $500 paid in tax to Switzerland will be credited to the taxpayer in computing the tax owed to the U.S. because the U.S. and Switzerland have a tax treaty.
In sum, a $100,000 foreign bank account resulted in two disclosure form filings to the U.S. and inclusion of the income on the U.S. citizen’s federal tax return. These are just the basics and every country has their own nuances. In addition, there are many special rules and there are numerous exceptions to the filing discussed herein and as a result a U.S. citizen leaving the U.S. or sending money outside the U.S. should seek out experienced professionals to assist them in their U.S. tax and disclosure reporting obligations.
I’m routinely asked questions about what taxes and rules apply when a distribution occurs from a retirement account. Here are the top ten rules you should know about distributions from retirement accounts.
The First 5 Facts Apply to Traditional IRA and 401(k) Accounts.
1. Early Withdrawal Penalty. A distribution from a traditional IRA or 401(k) before the account owner reaches 59 1/2 causes a 10% early withdrawal penalty on the amount distributed. This is in addition to taxes owed on the amount distributed. So, for example, if you take a $10,000 distribution from your traditional IRA at age 45 then you will be subject to a $1,000 penalty and you will also receive a 1099-R from your IRA custodian and will need to report $10,000 of income on your tax returns. Once you reach age 59 1/2, the 10% early withdrawal penalty does not apply.
2. Required Minimum Distributions. Whether you need the money or not, at age 70 1/2, the IRS requires a traditional IRA or 401(k) owner (unless still employed by employer 401(k)) to begin taking distributions from their retirement account. These distributions are subject to tax and the account owner will receive a 1099-R of the amount distributed that will be included on their tax return. The amount of the distribution is based on the person’s age and the account’s value. For example, someone with a $100K IRA who has turned 70 1/2 and is taking their first RMD would take $3,639 (3.79%).
3. Avoid Taking Large Distributions In One-Year. Because distributions from traditional retirement accounts are subject to tax at the time of distribution, it is wise to avoid taking too much in one year as a large distribution can push your distribution income and your other income into a higher tax bracket. For example, if you have employment and or rental/investment income of $50,000 annually then you are in a joint income tax bracket of 15% on additional income. However, if you take $100,000 as a lump-sum that year this will push your annual income to $150K and you will be in a 28% income tax bracket. If you could instead break up that $100K over two tax years then you could stay in 15% to 25% tax bracket and could reduce your overall tax liability. In short, only pull out what you need when you need it to lesson the immediate year’s tax liability.
4. Distribution Withholding. Most distributions from an employer 401(k) or pension plan (including solo K), before the age of 59 1/2, will be subject to a 20% withholding that will be sent to the IRS in anticipation of tax and penalty that will be owed. In the case of an early distribution from an IRA, a 10% withholding for the penalty amount can be made but you can also elect out of this automatic withholding provided you make an estimated tax payment or that you will otherwise be current on your tax liability.
5. If You Have Tax Losses, Consider Converting to a Roth IRA or Roth 401(k). When you have tax losses on your tax return you may want to consider using those losses to offset income that would arise when you convert a traditional IRA or 401(k) to a Roth account. Whenever you convert a traditional account to a Roth account, you must pay tax on the amount of the conversion. In the end though, you’ll have a Roth account that grows entirely tax-free and that you don’t pay taxes on when you distribute the money. Using the losses when they are available is a good way to get your Traditional retirement funds over to Roth.
The Final 5 Rules are For Roth IRAs and Roth 401(k)s.
1. Roth IRAs Are Exempt from RMD. While traditional IRA owners must take required minimum distributions (“RMD”) when the account owner reaches age 70 1/2, Roth IRAs are exempt from RMD rules. That’s a great perk and allows you to keep your money invested as long as possible.
2. Roth 401(k)s Must Take RMD. Roth 401(k) designated accounts are subject to RMD. This is a confusing rule since Roth IRAs are NOT subject to RMD. Such is the tax code. How can you avoid this? Simply roll your Roth 401(k) funds over to a Roth IRA when you reach 70 1/2.
3. Distributions of Contributions Are Always Tax-Free. Distributions of contributions to a Roth IRA are always tax-free. Regardless of age, you can always take a distribution of your Roth IRA contributions without penalty or tax.
4. Distributions of Roth IRA Earnings. In order to take a tax-free distribution from a Roth IRA, you must be age 59 1/2 or older and you must have had a Roth IRA for five years or longer. As long as those two criteria are met, all amounts (contributions and earnings) may be distributed from a Roth IRA tax free. If your funds in the Roth IRA are from a conversion, then you must have converted the funds at least 5 years ago and must be 59 1/2 or older in order to take a tax-free distribution.
5. Delay Roth Distributions. Roth retirement accounts are the most tax efficient way to earn income in the U.S. As a result, it is best to distribute and use other funds and assets that are at your disposal before using the funds built up in your Roth account as those funds aren’t as tax efficient while invested.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook
If you are assisting someone else’s company in raising money and are receiving a fee for doing so, then you must do such activities within the confines of the securities laws. These laws essentially provide three different ways in which one may legally raise money for another for a fee. You can’t get a “commission” or “bonus” or anything of value really for bringing an investor to another company or person unless you fit into one of these three categories.
BROKER DEALER LICENSE- First, if you are licensed and are registered with an SEC registered broker dealer you may receive commissions and other forms of compensation for raising money in public or private offerings (e.g. private placements). The newest form of registration from FINRA is designed to license and regulate those who operate as “investment bankers” and is called a Series 79 license. This license allows a holder to collect commissions and other fees for raising funds for an offering of equity (e.g. stock) or debt (e.g. notes or bonds). In addition to passing the licensing test, you’ll need to associate with a broker dealer.
FINDER’S FEE- Second, if you take a limited role in the raising of funds and are paid a flat or hourly fee, as opposed to commissions based on funds raised, you may be able to be paid a finder’s fee for introducing investors to others. A finder’s fee can only be paid to a finder so long as; a) the finder isn’t involved in negotiations of the securities being sold, b) the finder doesn’t discuss the details of the securities, c) the finder isn’t paid based on money raised (e.g. no commission), d) the finder doesn’t perform “finding” services on a regular basis. In sum, a finder’s fee may be paid but only to someone who makes introductions of potential investors and the fee amount must be based on some factor other than compensation relating the persons or amount of securities sold to those introduced by the finder.
DIRECTOR OR OFFICER OF OFFERING COMPANY- Third, you may be able to assist in raising funds for another if you are an officer or director of the company whom you are raising money for. The SEC promulgated Rule 3a4-1 which is a Safe Harbor from enforcement and allows someone who serves as a paid Director or Officer to assist in selling the company’s securities. There are many ways to qualify under this Rule but the most common is to meet the following criteria; a) be paid as a director or officer by salary or other criteria that is not linked to sales of securities made (e.g. be the CFO or Treasurer and offer financial consulting advice in addition to working with potential investors), b) can’t be associated with a broker dealer and cannot have a prior SEC disciplinary history, c) should stay on with the company following closing of the offering so as to show your purpose as a Director or Officer was not just for raising funds, d) takes a passive and restrictive role in selling the securities and refers to the CEO or President for details and negotiations.
Failure to comply with the securities laws can result in civil and criminal action. In addition, investors who can claim a failure to comply with the laws outlined above are able to rescind their investment and can subject the company’s founders and the person soliciting the investment with personal liability for any losses.
President Trump’s private lawyer, Michael Cohen, recently had his home and office raided by federal agents. But wait, isn’t all of his information attorney-client privileged? If you’re confused at how a lawyer’s records could be raided, your instincts are right. We’ve all learned about the fourth amendment, which protects us against unreasonable search and seizure, and requires the government to obtain a warrant. But, lawyer records and client information is especially protected, and any old warrant won’t allow the government to search or seize a lawyer’s records. In the case of Trump’s private lawyer, Michael Cohen, the government was able to blow past attorney-client privilege by alleging and providing credible information that they suspected Mr. Cohen was part of criminal activity himself. So, what can upstanding business owners learn from the Michael Cohen saga? Well, quite a bit.
When planning your business and tax structure with your lawyer, it is important to understand what is privileged and what is not. Often times, clients divulge information to their lawyer and wonder whether that information is “attorney-client privileged” or not. Attorney-client privilege is an important legal protection offered to persons, companies, and organizations who provide confidential information and who seek counsel from their lawyer or law firm. Under law, an attorney cannot be required to provide attorney-client privileged information to a plaintiff in a law suit (e.g. creditor) or to a government agency (e.g. the IRS) except under limited situations. Here are a couple of common situations where you may lose attorney-client privilege and some tips to make sure your confidential information provided to your lawyers doesn’t run into the exceptions.
Exceptions to the Attorney-Client Privilege Rule
1. Third-party non-lawyer present
Was a third-party present with your lawyer when the information you want to be privileged was discussed. For example, was your accountant or financial adviser present when discussing information you want to remain confidential and to privileged? Keep in mind that if a third-party is present in a meeting or on a conference call then that third-party may be required to provide information or documents from the meeting and that your accountant, consultant or adviser can’t raise the attorney-client privileged defense for you unless they’re actually your attorney. If a third-party professional does need to be hired (e.g. an accountant or CPA), that third-party can be hired or brought into the matter by the attorney and the privilege may remain intact. This is known as a “Kovel” hiring of the accountant, and stems from a case where a lawyer engaged an accountant for the client, and the accountant’s work was therefore covered under the lawyer’s attorney-client privilege.
Tip: For sensitive matters where you want information to remain confidential and privileged, do not involve outside parties as those outside parties or non-attorney advisers cannot raise the attorney-client privileged defense.
2. Only legal advice is attorney-client privileged
Only information exchanged when seeking legal advice is attorney-client privileged. This is especially tricky for companies who have their own “in-house” legal counsel who also offers business advice. Only the information exchanged that pertains to legal advice would be privileged. For example, was an organization chart of the company’s holdings “privileged” when provided to the company lawyer who also manages those assets for the business? Also, what if that lawyer disseminated that organization chart to accountants, property managers, or other non-lawyers? If they did, then that information is no longer attorney-client privileged.
Tip: If you have sensitive documents or information you want to keep in communication only with your lawyer, ask your attorney to identify the document as “Attorney-Client Privileged” and do not provide it to non-lawyers.
3. If the lawyer is on the crime, it is no longer attorney-client privileged
This tip comes compliments of the Michael Cohen case outlined at the beginning of this article. You may also think of “Breaking Bad’s” famed lawyer, Saul Goodman. Or maybe you’re “The Godfather” kind of person, and you think of the mafia lawyer, Tom Hagen. In the case of Goodman and Hagen, they were lawyers who were part of the criminal enterprise of their bosses. As a result, their records are not protected by attorney-client privilege.
Tip: While this third scenario is less likely applicable to our readers, I hope, it’s more fun to talk about than when your accountant can receive incriminating information.
Remember that not all information provided to your lawyer needs to be attorney-client privileged. Keep these tips in mind when communicating highly-sensitive information to your attorney, and let your attorney know before you provide the confidential information that you intend it to be privileged, so that they can ensure that your information is properly handled and so that non-lawyer third-parties are only involved when the privilege can be maintained.