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 If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law.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.
You have until April 18th, 2017 to make 2016 IRA contributions for Roth and Traditional IRAs. If you’re self-employed and are using a SEP, your deadline is determined by your company’s tax filing deadline (e.g. s-corp, partnership, or sole prop). So, if you were an s-corp or partnership in 2016, then your filing deadline was March 15th, 2017. II you are a sole prop, then the deadline is April 18th, 2017. If you extended your company return, that extension will also apply to your SEP IRA contributions. The table below breaks down the deadlines and extension options for Traditional, Roth and SEP IRAs.
|Type of IRA
||April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 219(f)(3); You can file your return claiming a contribution before the contribution is actually made. Rev. Rul. 84-18.
||Roth, Not Deductible
||April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7).
||N/A: Employee contributions cannot be made to a SEP IRA plan.
|Employer Contribution, Deductible
||March 15/April 15th: Due Date for Company Tax Return Filing (including extensions). IRC § 404(h)(1)(B).
As outlined above, you have until the 2016 individual tax return deadline of April 18th, 2017 to make 2016 Traditional and Roth IRA contributions. The deadline for Traditional and Roth IRAs, however, does not include extensions. So, even if you extend your 2016 tax return, your 2016 Traditional and Roth IRA contributions are still due on April 18th, 2017.
SEP IRA contribution deadlines are based on the company tax return deadline, which could be March 15th if the company is taxed as a corporation (“c” or “s”) or partnership, and April 15th if it is a sole proprietorship. Keep in mind that this deadline includes extensions, so if you extend your company tax return filing, you will extend the time period to make 2016 SEP IRA contributions.
Self-Directed IRA investors should be aware of the following IRA tax reporting responsibilities. Some of these items are completed by your custodian and some of them are the IRA owner’s sole responsibility. Here’s a quick summary of what should be reported to the IRS each year for your self-directed IRA.
IRA Custodian Files
Your IRA Custodian will file the following forms to the IRS annually.
||WHAT DOES IT REPORT
||Filed to the IRS by your custodian. No taxes are due or paid as a result of Form 5498.
IRA contributions, Roth conversions, the account’s fair market value as of 12/31/16, and required minimum distributions taken.
||Filed to the IRS by your custodian to report any distributions or Roth conversions. The amounts distributed or converted are generally subject to tax and are claimed on your personal tax return.
||IRA distributions for the year, Roth IRA conversions, and also rollovers that are not direct IRA trustee-to-IRA trustee.
IRA Owner’s Responsibility
Depending on your self-directed IRA investments, you may be required to file the following tax return(s) with the IRS for your IRA’s investments/income.
||DOES MY IRA NEED TO FILE THIS?
|1065 Partnership Tax Return
||If your IRA is an owner in an LLC, LP, or other partnership, then the Partnership should file a 1065 Tax Return for the company to the IRS and should issue a K-1 to your IRA for its share of income or loss. Make sure the accountant preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1’s and not your personal SSN (or your IRAs Tax ID if it has one for UBIT 990-T tax return purposes). If your IRA owns an LLC 100%, then it is disregarded for tax purposes (single-member LLC) and the LLC does not need to file a tax return to the IRS.
||March 15th, 6-month extension available
|990-T IRA Tax Return (UBIT)
||If your IRA incurs Unrelated Business Income Tax (UBIT), then it is required to file a tax return. The IRA files a tax return and any taxes due are paid from the IRA. Most self-directed IRAs don’t need to file a 990-T for their IRA, but you may be required to file for your IRA if your IRA obtained a non-recourse loan to buy a property (UDFI tax), or if your IRA participates in non-passive real estate investments such as: Construction, development, or on-going short-term flips. You may also have UBIT if your IRA has received income from an active trade or business such as a being a partner in an LLC that sells goods and services (C-Corp dividends exempt). Rental real estate income (no debt leverage), interest income, capital gain income, and dividend income are exempt from UBIT tax.
||April 15th, 3-month extension available
Most Frequently Asked Questions
I’ve answered the most frequently asked questions below as they relate to your IRA’s tax reporting responsibilities.
Q: My IRA is a member in an LLC with other investors. What should I tell the accountant preparing the tax return about reporting profit/loss for my IRA?
A: Let your accountant know that the IRA should receive the K-1 (e.g. ABC Trust Company FBO John Doe IRA) and that they should use the Tax-ID of your custodian and not your personal SSN. Contact your custodian to obtain their Tax ID. Most custodians are familiar with this process, so it should be readily available.
Q: Why do I need to provide an annual valuation to my custodian for the LLC (or other company) my IRA owns?
A: Your IRA custodian must report your IRA’s fair market value as of the end of the year (as of 12/31/16) to the IRS on Form 5498 and in order to do this they must have an accurate record of the value of your IRA’s investments. If your IRA owns an LLC, they need to know the value of that LLC. For example, let’s say you have an IRA that owns an LLC 100% and that this LLC owns a rental property and that it also has a bank account with some cash. If the value of the rental property at the end of the year was $150,000, and if the cash in the LLC bank account is $15,000, then the value of the LLC at the end of the year is $165,000.
Q: I have a property owned by my IRA and I obtained a non-recourse loan to purchase the property. Does my IRA need to file a 990-T tax return?
A: Probably. A 990-T tax return is required if your IRA has income subject to UBIT tax. There is a tax called UDFI tax (Unrelated Debt Financed Income) that is triggered when your IRA uses debt to acquire an asset. Essentially, what the IRS does in this situation is they make you apportion the percent of your investment that is the IRA’s cash (tax favorable treatment) and the portion that is debt (subject to UDFI/UBIT tax) and your IRA ends up paying taxes on the profits that are generated from the debt as this is non-retirement plan money. If you have rental income for the year, then you can use expenses to offset this income. However, if you have $1,000 or more of gross income subject to UBIT, then you should file a 990-T tax return. In addition, if you have losses for the year, you may want to file 990-T to claim those losses as they can carry-forward to be used to offset future gains (e.g. sale of the property).
Q: How do I file a 990-T tax return for my IRA?
A: This is filed by your IRA and is not part of your personal tax return. If tax is due, you will need to send the completed tax form to your IRA Custodian along with an instruction to pay the tax due and your custodian will pay the taxes owed from the IRA to the IRS. Your IRA must obtain its own Tax ID to file Form 990-T. Your IRA custodian does not file this form or report UBIT tax to the IRS for your IRA. This is the IRA owner’s responsibility. Our law firm prepares and files 990-T tax returns for our self-directed IRA and 401(k) clients. Contact us at the law firm if you need assistance.
Sadly, not many professionals are familiar with the rules and tax procedures for self-directed IRAs so it is important to seek out those attorneys, accountants, and CPAs who can help you understand your self-directed IRA tax reporting obligations. Our law firm routinely advises clients and their accountants on the rules and procedures that I have summarized in this article and we can also prepare and file your 990-T tax return.
The RISE Act proposed by Senator Ron Wyden of Oregon would significantly impact self-directed IRAs. I previously wrote about the bill here and provided a detailed analysis. In summary, the bill would require that all self-directed IRA investment purchases be valued by a third-party appraiser and reported on the IRA owner’s personal tax return. In addition, the Act would change the disqualified person rule for companies from 50% to 10%. The Act also greatly effects Roth IRAs and would eliminate Roth conversions and would cap Roth IRA accounts at $5M.
Here are few quick updates that are very important to the bill.
- Senator Orrin Hatch of Utah (R) has introduced the Retirement Enhancement and Savings Act of 2016. This bill is farther long in the process and addresses retirement account issues but is entirely un-related to Senator Wyden’s proposed RISE Act the impacts self-directed IRAs. I’ve had a few clients worried as they’ve ran across this bill as it is currently working its way through the Senate.
- Senator Wyden’s RISE Act is in proposed form and is out for comment until December 7, 2016. You can reply with comments to Retirement_Savings@finance.senate.gov. I will post my Comment in a subsequent blog article.
- While the bill is sponsored by Democrat Senator in a Republican controlled Senate, it is still vitally important that the Senate Finance Committee understand the roadblocks and burdens that the bills IRA provisions will cause to hundreds of thousands of Americans who are investing for retirement with their self-directed IRA.
- If your Senator is a member of the Senate Finance Committee, I would highly recommend sending focused and professional comments to your Senator regarding provisions that will hinder your ability to save and invest for retirement. The current members of the Senate Finance Committee can be found here.
Additionally, if you have comments or feedback relative to the proposed bill, please feel free to that to me at email@example.com.