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.
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.
You have a number of options and decisions to make when moving funds from a retirement account (401(k), 403(b), IRA) to an IRA. And you’ve got to be careful because sometimes checking the wrong box on your transfer, rollover, and withdrawal forms can have drastic tax consequences. For example, should you move funds from one retirement account to your IRA using a Direct Rollover, a 60-Day Rollover, or a Trustee-to-Trustee transfer? Which box do you check on your form and does a 1099-R get issued and reported to the IRS? Will I have to report anything on my tax return? Let’s go over the options and the consequences as well as the tax reporting for each one.
1. Direct Rollover from 401(k) to IRA – When Moving from an Employer Plan
A Direct Rollover is generally used when moving funds from an employer plan (e.g. former employer 401(k) or 403(b)) to an IRA). Under a direct rollover, the retirement plan administrator will send the retirement plan funds directly to the new custodian of your IRA. There is no tax consequence and there is no withholding. There is simply a “direct” rollover of the funds to the new IRA account. Most employer plans like 401(k)s and 403(b)s are traditional accounts, so those funds are generally rolled to a traditional IRA. If you are moving the funds to a Roth IRA, which is possible, you will need to covert the funds with the IRA custodian as they are being rolled into a Roth IRA. And of course, there are taxes due from the Roth conversion.
There are no limits on the number of Direct Rollovers you may complete, except as may be reasonably imposed by your employer’s retirement plan. For example, some employer plans may say that it’s an all or nothing option if you want to move funds once you no longer work there (e.g. keep all your funds there or move everything to an IRA).
If you are currently employed with your employer, you are usually only allowed to move funds from the employer’s plan when you have reached retirement plan age under the plan. This is usually 55 or 59 1/2 depending on your employer’s plan.
A direct rollover from an employer plan is not subject to tax or withholding. When a direct rollover is completed, a 1099 is generally issued from the current plan, but is marked as “not taxable” as the funds are being sent to another qualifying retirement account.
2. 60-Day Rollover – Only When You Need It This Way
A 60-Day Rollover allows you to take a distribution from one IRA, so long as you re-deposit that same amount into another IRA within 60 days, and the funds no longer considered distributed. When using a 60-Day Rollover, you receive the funds personally from the current IRA plan custodian, and then re-deposit those funds into a qualifying IRA within 60 days. Failure to re-deposit in time will cause a distribution of the funds, and you will be subject to taxes on any applicable penalties (e.g. early withdrawal penalty if under 59 1/2) for failure to re-deposit in time. There are no extensions, and there is no mercy if you miss the 60-day deadline. The new IRA custodian will generally require a certification, and your prior IRA account custodian’s statement to verify that the funds were in an IRA within the past 60 days.
It is very important to note that as of 2013 you can only complete one 60-Day Rollover every twelve months. See my prior article here on the 12-month rule for 60-Day Rollovers. Consequently, you should not use the 60-Day Rollover method option on a regular basis.
When using a 60-Day Rollover, the former IRA custodian will issue a 1099-R reporting the distribution as taxable and you will need to certify that you re-deposited within 60 days on your personal tax return to avoid the distribution. The 60-Day Rollover is communicated to the IRS on your personal tax return on line 15 where you report the distribution from the 1099-R, and then on line 15b you report that it was not taxable, since it was rolled over within 60 days. On line 15b, you indicate that the taxable amount is zero and you write the word Rollover next to line 15b. See the IRS instructions for line 15 here.
3. Trustee-to-Trustee Transfer – the Best Option When Changing IRA Custodians
The Trustee-to-Trustee transfer is the preferred method of moving funds from one IRA to another (e.g. from a Roth IRA at Fidelity to a Roth IRA with a self-directed custodian). Under a Trustee-to-Trustee transfer, the funds are sent from one IRA custodian (partial or full account) to your new IRA custodian. There is no tax, withholding, or penalty for moving funds via a Trustee-to-Trustee transfer, and there is no limit on the amount of Trustee-to-Trustee transfers you may complete.
A 1099-R is not issued when a Trustee-to-Trustee transfer occurs, and there is no withholding or tax due. Consequently, the Trustee-to-Trustee transfer is the preferred method to use when moving funds from one IRA to another.
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
Summer is great time to think about college and to make financial plans for your kids. Better yet, let them make money over the summer and put it in a tax-favorable college savings account. As you consider their plan options, consider the two most common tax favored savings tools available.
There are two types of accounts that you can establish to save for higher education expenses in a tax favorable manner. These two types of accounts are Coverdell Education Savings Accounts and 529 Plan accounts.
The first type of account is known as a Coverdell Education Savings Account. A Coverdell account is typically set up for the higher education expenses of a child. The contributed funds grow in the account tax deferred and the money comes out for education expenses tax free. There is no tax deduction for amounts contributed to a Coverdell but you do have significant investment options including self-directed investment options (similar to IRA rules). A Coverdell has the following rules and benefits.
- $2,000 annual contribution limit per beneficiary (e.g. child or grandchild).
- Parents (or grandparents) can contribute without limitations to a Coverdell until a beneficiary reaches age 18 if the contributor has income of less than $190k (married joint) or $110,000 (single). For high-income earners, keep in mind that the child can always contribute to their own account with gifted funds (no need to have earned income) so you can always get around the income limitation by having the child contribute themselves.
- Funds can be used for tuition, fees, books, and equipment for college as well as certain K-12 expenses too.
- There are zero federal or state income tax deductions on Coverdell accounts.
- Accounts can be invested into stocks, mutual funds, and can even be self-directed. They operate similar to an IRA.
- Contributions grow tax-free and can be withdrawn for education expenses until the account beneficiary reaches age 30. Unused amounts can be transferred to another family member beneficiary.
The second type of account is a 529 Plan account. Contributions to 529 Plan accounts can be eligible for a state income tax deduction (depending on the state). Money contributed to a 529 Plan account is invested into a state managed fund. A 529 has the following rules and benefits.
- Amounts are invested into a state run program.
- Amounts can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
- Up to a few hundred thousand dollars can be invested per beneficiary by any person.
- There are no federal tax deductions or credits for contributions.
- Many states offer tax deductions for contributions to 529 Plan accounts. For example, Arizona offers a $4,000 tax deduction for married tax filers and a $2,000 deduction for single filers. Thirty-five states offer some type of state income tax deduction for 529 Plan contributions. However, there are some states, like California, who offer no tax deduction for contributions to 529 Plan accounts. Click here to see a comprehensive list that outlines the different state funds and tax deductions (or credits for some states).
- Downside, invested amounts must be invested solely into state run programs. There are no other investment options.
In summary, Coverdell accounts have the benefit of allowing account owner’s to decide how the money will be invested with zero tax deductions available on contributions while 529 Plan accounts give you zero investment options (all funds go to state run fund) but offer state income tax deductions in most states.
If you live in a state that offers a tax deduction on contributions, such as Arizona, then the 529 Plan account is a great option if you can stomach having the money go into a state run fund. On the other hand, if you live in a state with zero income tax (e.g. Texas or Florida) or if you live in state with zero 529 Plan deductions (e.g. California) then you might as well use a Coverdell account because you’re not trading any tax deductions for investment options. For those who can’t make up their mind and who have the funds, consider doing both but do the Coverdell first. There is no restriction against doing a Coverdell account (no tax deductions, but investment options) and a 529 Plan account (possible state tax deductions but no investment options).