Do you have a solo 401(k)? Have you been filing form 5500-EZ each year for the solo 401(k)? Are you aware that there is a penalty up to $15,000 per year for failure to file? While some 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.
The return a Solo 401(k) files is called a 5500-EZ and it is due annually on July 31st for the prior year. If you you have a solo 401(k) and you 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). Solo 401(k)s with less than $250,000 in assets are exempt and do not need to file a 5500-EZ. All plans with assets valued at $250,000 or greater must file a form 5500-EZ annually. A tax return is also required for a Solo 401(k) when the plan is terminated, even if the plan assets are below $250,000. 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. The penalty relief began as a temporary program in 2014 and was made permanent via Rev Proc 2015-32.
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. There is a $500 fee due for each delinquent return up to a total of $1,500 or three years. This program is available to all solo 401(k) plans, regardless of whether it is a self-directed plan.
The IRS has provided details via Rev Proc 15-32. In order to qualify and receive a waiver of penalties under the program, you must follow the program exactly. In short, you must do all of the following:
- File all delinquent returns using the IRS form in the year the filing was due. This must be via paper form.
- Mark on the top margin of the first page, “Delinquent Return Submitted under Rev. Proc. 2015-32.”
- Complete and include IRS Form 14704.
- Mail all documents to the IRS, Ogden, UT office.
In sum, if you have a solo 401(k) plan that should have filed a 5500-EZ for prior years, then you should take advantage of this program, which will save you literally thousands of dollars in penalties and fees. 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.
Solo 401(k)s have become a popular retirement plan option for self-employed persons. Unfortunately, many of the plans are not properly maintained and are at the risk of significant penalty and/or plan termination. If you have a Solo 401(k), you need to ensure that the 401(k) is being properly maintained. Here’s a quick checklist to make sure your plan is on track.
- Is the Plan Up-to-Date? The IRS requires all 401(k) plans, including solo 401(k)s, to be amended at least once every 6 years. If you’ve had your plan over 6 years and you’ve never restated the plan or adopted amendments, it is not compliant and upon audit you will be subject to fines and possible plan termination (IRS Rev Proc 2016-17). If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law. On average, most plan documents we see update every 2-3 years as the laws effecting the plan documents change.
- Are You Properly Tracking Your Plan Funds? Your solo 401(k) plan funds need to be properly tracked and they must identify the different sources for each participant. For example, if two spouses are contributing Roth 401(k) employee contributions and the company is matching traditional 401(k) dollars, then you need to be tracking these four different sources of funds, and you must have a written accounting record documenting these different fund types.
- Plan Funds Must Be Separated by Source and Participant. You must maintain separate bank accounts for the different participants’ funds (e.g. spouses or partners in a solo K), and you must also separate traditional funds from Roth funds. In addition, you must properly track and document investments from these different fund sources so that returns to the solo 401(k) are properly credited to the proper investing account.
- Does Your Solo 401(k) Need to File a Form 5500? There are two primary situations where you may be required to file a Form 5500 for your solo 401(k). First, if your solo 401(k) has more than $250,000 in assets. And second, if the solo 401(k) plan is terminated (regardless of total asset amount). If either of these instances occur, then the solo 401(k) must file a Form 5500 to the IRS annually. Form 5500 is due by July 31 of each year for the prior year’s plan activity. Solo 401(k)s can file what is known as a 5500-EZ. The 5500-EZ is a shortened version of the standard Form 5500. Unfortunately, the Form 5500-EZ cannot be filed electronically and must be filed by mail. Solo 401(k) owners have the option of filing a Form 5500-SF on-line through the DOL. The on-line filing is a preferred method as it can immediately be filed and tracked by the plan owner. In fact, if you qualify to file a 5500-EZ, the IRS/DOL allow you file the Form 5500-SF on-line but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ.
- Are You Properly Reporting Contributions and Rollovers? If you’ve rolled over funds from an IRA or other 401(k) to your solo 401(k), you should’ve indicated that the rollover or transfer was to another retirement account. So long as you did this, the company rolling over the funds will issue a 1099-R to you, but will include a code on the 1099-R (code G in box 7) indicating that the funds were transferred to another retirement account, and that the amount on the 1099-R is not subject to tax. If you’re making new contributions to the solo 401(k), those contributions should be properly tracked on your personal and business tax returns. If you are an s-corp, your employee contributions should show up on your W-2, and your employer contributions will show up on line 17 of your 1120S s-corp tax return. If you are a sole prop, your contributions will typically show up on your personal 1040 on line 28.
Make sure you are complying with these rules on an annual basis. If your solo 401(k) retirement plan is out of compliance, get with your attorney or CPA immediately to make sure it is up-to-date. Failure to properly file Form 5500 runs at a rate of $25 a day up to a maximum penalty of $15,000 per return not properly filed. You don’t want to get stung by that penalty for failing to file a relatively simple form. The good news is there are correction programs offered for some plan failures, but don’t get sloppy, or you’ll run the risk losing your hard-earned retirement dollars.
Self-employed persons have two options when it comes to establishing a retirement account. If you are self-employed and you want to save for retirement, two of your primary options will be a SEP IRA or a Solo 401K. The SEP IRA is a super-charged IRA account that runs off of IRA rules while the Solo 401(K) is an employed based retirement plan used solely for the business owner(s) when they have no other employees.
Both a SEP IRA and a Solo 401(k) can be self-directed and invested into real estate, private company stock, or precious metals. Under a SEP IRA, you will have a self-directed IRA custodian. Under a Solo 401K, you can serve as your own trustee and administrator or you could use a custodian.
While a SEP IRA and a 401(k) can be used by business owners with employees other than the business owners, this article compares the two account options for those who are self-employed with no other employees other than themselves (and partners and family).
||$53,000 max annual contribution (it takes $265K of self-employment income to max out). Contributions are all employer contributions.
||$53,000 max annual contribution (it takes $140K of wage/se income to max out). Contributions are employee and employer. Because a solo K is easier to max out each year on less income, it gives greater opportunity for utilization over the SEP IRA.
|Traditional & Roth
||All SEP contributions are traditional dollars and all funds in a SEP must be traditional dollars. SEP IRA funds can be converted to a Roth IRA though.
||A solo 401(k) can have a traditional account and a roth account within the same plan. You can convert traditional sums over to Roth as well. Because you can have Roth accounts and Traditional account in the 401K, that provides more options in the solo 401(k).
|Contribution & Establishment Deadline
||Date of the company tax return INCLUDING extensions. You may also establish a new SEP IRA at the time you make the first contributions even if that is for the prior tax year. For people making contributions for the first time for a prior year (e.g. in April of 2015 for 2014 contributions), this is a big benefit as a 401K) cannot be used unless it was set up in the tax year of the contribution.
||Date of the company tax return INCLUDING extensions. However, for new plans, they must be established by December 31 of the year you are seeking to make contributions. This means you have to plan ahead and establish the 401(k) before the end of the year.
||An IRA must have a third party custodian involved on the account (e.g. bank. Credit union, trust company) who is the trustee of the IRA.
||A 401(k) can be self trusteed, meaning the business owner can be the trustee of the 401(k). This provides for greater control but also greater responsibility.
||A SEP IRA is invested through the self directed IRA custodian. A SEP IRA can be subject to a tax called UDFI/UBIT on income from debt leveraged real estate.
||A Solo 401(k) is invested by the trustee of the 401(k) which could be the business owner. A solo 401(k) is exempt from UDFI/UBIT on income from debt leveraged real estate.
In sum, there are many differences between a solo 401(K) and a SEP IRA but the solo 401(k) has proven to be an excellent tool that provides greater flexibility when saving and investing for retirement.