Top Three Mistakes in Solo 401(k) Plans

Photo of a statue facepalming with the text "op Three Mistakes in Solo 401(k) Plans."Solo 401(k) plans have being growing in popularity with self-employed persons. Solo 401(k)s are an excellent tool for self employed persons to maximize contributions in their own business or self-employment just like large companies who offer plans for their employees. The basic rules for solo 401(k)s are that you must be self-employed and that you must have a no other employees other than the business owner and family. As happens with many good things, this is starting to get over-sold and we are seeing common problems arise with persons who create them on-line and with the assistance of someone who has no credentials or experience outside of creating a catchy website. Here are a few things to watch out for.

Top Three Mistakes in Solo 401(k) Plans

 

1. Failure to Update/Amend– Pursuant to Revenue Procedure 2007-44, 401(k) plans shall be amended and restated every six years to conform with current law. The company who provided your plan document, usually what is called a pre-approved plan document for solo 401(k)’s, should be providing you with these updates so that your plan stays in compliance with the amendment cycles established by the IRS. Failure to properly update the plan can result in significant penalties and revocation of tax status.

2. Using an LLC With Rental Income as The Employer/Company – Solo 401(k)s must be established by an employer company. Unlike IRAs, where any individual may establish an account, a 401(k) may only be established by a company and is a benefit for its employees. For example, a solo 401(k) for a self-employed real estate agent with no other employees is created for the real estate agent who is the sole employee/owner. For many self-employed persons who have no other employees, this type of 401(k) is an excellent retirement plan too.

Unfortunately, the solo 401(k) is being oversold and over promoted to real estate investors who only own rentals. We have seen many promoters (operating out of a basement somewhere) who state that you can establish a solo 401(k) with your LLC that owns rental real estate. After all, they say, the LLC is a company and you are the only owner. Therefore this company can establish a solo 401(k). This is only partly true. The LLC that owns rental properties is not a proper entity in which to establish a solo 401(k) since the LLC receives “rental income” and since the owners of the LLC are not considered “employees” receiving wages or earned income that may be contributed to a retirement account. Rental income cannot be contributed to a retirement account and as a result the owner of the LLC is not an employee or person receiving earned income that qualifies to have a solo 401(k) account. All 401(k)s, solo 401(k)s included, must be established by a company for the benefit of its employees with wages or earned income. See IRS Publication 560. As a result, we recommend that clients use companies where wage income (e.g. s-corps) or self-employment income that creates earned income on schedule C  be used to establish a solo 401(k). While an LLC may be used to adopt a solo 401(k), that would only be the case if the LLC receives ordinary income for its owner that is then claimed on schedule C of the owner’s tax return.

3. Failing to File Form 5500-SF – In general, 401(k)s are required to file a return called from 5500. Solo 401(k)s, however, have some exemptions to the 5500 filing requirement but there are many situations where a solo 401(k) is still required to file an annual form 5500 return. The first instance where a 5500-SF tax return is required is when the solo 401(k) has over $250,000 in assets. The second instance is when the plan is terminated. Regardless of assets, a form 5500 must still be filed at termination.

Our law firm has experience in creating solo 401(k)s that can be self-trusteed and self-directed and we also assist our clients with annual maintenance, plan amendments, and required annual 5500-SF filings. Contact us at the law firm to learn more information about our services.

How to Avoid the $15000 Solo 401(k) “Failure to File 5500-EZ” Penalty

Photo of the exterior of the IRS building with the text "How to Avoid the $15000 Solo 401(k) "Failure to File 5500-EZ" Penalty."Do you have a solo 401(k)? Have you been filing form 5500-EZ each year for the 401(k)? Are you aware that there is a penalty up to $15,000 per year for failure to file? While many solo 401(k)s are exempt from the 5500-EZ filing requirement, we have ran across many solo 401(k) owners who should have filed and who have failed to do so. If you you have a solo 401(k) and have no idea what I’m talking about, stay calm, but read on.

One of the benefits of a solo 401(k) is the ease of administration and control because you can be the 401k trustee and administrator. However, as the 401(k) administrator and trustee it is your own responsibility to make the appropriate tax filings. This would include filing any required tax returns  for the 401(k).  In general, there is no tax return to file for a self-directed solo 401(k).  However, one exception to this rule is if the plan assets exceed $250,000 at the end of the plan year, in which case, a tax return filing is required.  The return the 401(k) files is called a 5500-EZ.  Recently, more and more solo 401(k) owners have contacted us because they set up their solo 401(k) online or with some other company and they were never made aware that they are supposed to file a 5500-EZ when their plan assets exceed $250,000.  Some of these individuals have multiple years in which they should have filed the 5500-EZ but failed to do so.  The penalties for failing to file a 5500-EZ when it is required can be quite severe, with fees and penalties as high as $15,000 for each late return, plus interest.

Fortunately, the IRS has a temporary pilot program that provides automatic relief from IRS Late filing penalties on past due 5500-EZ filings.  This temporary program began on June 2, 2014 and will end on June 2, 2015. The IRS has yet to decide if they will continue with this program and make it permanent after June 2, 2015, but if they do, they plan to charge a filing fee.  Under this temporary program, there is no filing fee.

In order to qualify for this program, your solo 401(k) plan must not have received a CP 283 Notice for any past due 5500-EZ filings, and the only participants of your solo 401(k) plan can be you and your spouse, and your business partner(s) and their spouse.  This program is available to all solo 401(k) plans, regardless of whether it is a self-directed plan.

The IRS has provided a step-by-step process that can be found at http://www.irs.gov/Retirement-Plans/New-Penalty-Relief-Program-for-Form-5500-EZ-Late-Filers and at http://www.irs.gov/pub/irs-drop/rp-14-32.pdf.   In order to qualify and receive a waiver of penalties under the program, you must follow the program exactly.  Basically, you must do all of the following:

  1. File all delinquent returns using the IRS form in the year the filing was due.
  2. Write in red letters at the top of the first page of each filing, “Delinquent return submitted under Rev. Proc. 2014-32, Eligible for Penalty Relief”.
  3. Attach a one page transmittal schedule to the front of each filing.
  4. Mail all documents to the IRS.

In sum, if you have a solo 401(k) plan that should have filed a 5500-EZ for years past because the plan assets exceeded $250,000 at the end of the plan year, then you should take advantage of this program, which will save you literally thousands of dollars in penalties and fees.  Under this program, the IRS must receive your past due 5500-EZ filings before June 2, 2015.  If you have any questions about this program or would like assistance with submitting your late 5500-EZ filings under this program, please contact the law firm as we are assisting clients with current and past due 5500-EZ filings for their solo 401(K)s.