Solo 401(k)s have become a popular retirement plan option for self-employed persons. Unfortunately, many 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:
1. Does your Solo 401(k) need to file a Form 5500-EZ?
There are two primary situations where you are required to file a Form 5500 for your Solo 401(k).
- If your Solo 401(k) has more than $250,000 in assets, and
- 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 31st 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 online through the DOL. The online filing is preferred as it can immediately be filed and tracked by the plan owner. In fact, if you qualify to file a 5500-EZ, the IRS and DOL allow you file the Form 5500-SF online, but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ. We regularly file Form 5500-EZs and 5500-SFs for Solo K clients in the law firm for only $250.
2. 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 six years. If you’ve had your plan over six 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 If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law.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 two to three years as the laws effecting the plan documents change. We’ve had two different plan amendments to our IRS pre-approved plan in the past six years.
3. 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 employer 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.
4. 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.
5. 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 have 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 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.
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.
Self-directed 401(k) owners, companies in the industry, and many professionals have been confused on what rules, if any, govern when buying precious metals with a self-directed 401(k). There is a code section in IRC § 408(m) that outlines what metals can be owned by a self-directed IRA and how they should be stored. I have an article that summarizes it here. However, this section of the code is written for IRAs, and many have questioned whether it should be applied to 401(k) accounts as well. The short answer is, “Yes,” and here are two reasons why:
I. Most Solo K plan documents adopt IRC § 408(m)
Most 401(k) plans, including Solo 401(k)s, adopt IRC § 408(m), which specify which precious metals your Solo K may own, and provides a storage requirement. Since the plan documents restrict what precious metals your 401(k) may own, all accounts under the plan must follow the plan rules. Many may wonder, “Well can’t I just amend my 401(k) plan?”
Not exactly. Most Solo K plans are volume-submitter IRS pre-approved plans and take years to create and get approved with the IRS. A change requires approval from the provider of those plans, and they’d have to change it for all of their customers. This isn’t likely to occur, especially given second point below.
II. The IRS wants your Solo K to follow the IRA “Precious Metals” rule
The IRS has issued guidance to 401(k) plans that are individually directed and has stated that the rules of IRC § 408(m) should be followed when a 401(k) account purchases precious metals. To view the IRS analysis, check out their resource page here.
Consequently, Solo 401(k) owners buying precious metals should follow the IRA rules for precious metals and should only buy qualifying gold, silver, platinum, or palladium, and should make sure that such metals are stored with a third party qualifying institution (bank, credit union, or trust company).
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, but 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 have a Solo 401(k) and you have no idea what I’m talking about, stay calm, but read on.
Benefits of Solo 401(k)s
One of the benefits of a Solo 401(k) is the ease of administration and control, because you can be the 401(k) 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 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.
Failure to File Relief
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 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 our law firm as we are assisting clients with current and past due 5500-EZ filings for their Solo 401(k)s.
Solo 401(k) plans have grown significantly and are often used by self-directed investors. 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 or 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 there is 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-EZ – 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-EZ return. The first instance where a 5500-EZ 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-trustee’d and self-directed and we also assist our clients with annual maintenance, plan amendments, and required annual 5500-EZ filings. Contact us at the law firm to learn more information about our services.