excess contribution to Roth solo 401k
Taxpayer funded Solo roth 401k with $35K in February, 2020. This exceeded the 2020 limit by $9,000. The account balance is now $87,000. The taxpayer also has an existing regular solo 401k. The overfunding was not corrected prior to January 1, 2021. It will be corrected by April 15, 2021. What is the best solution to correct the overfunding error? Mechanics of dealing with the $9,000 overfunding and the related significant earnings to date?
Permalink Submitted by Alan - IRA critic on Wed, 2021-01-27 18:46
Assuming these contributions were all elective deferrals for 2020, the excess amount must be distributed with allocated earnings by 4/15. The earnings calculation ends on 12/31/2020. Since Roth deferrals are post tax, the excess amounts will not be included in 2020 wages, but the earnings distributed with the deferrals will be taxable income in 2021 (the year of the distribution), and added to 2021 wages when the 2021 return is filed. There will be separate 1099R forms for the distribution of the excess and the distribution of the earnings, but since tax will only be due on the earnings in 2021, the 2020 return will not be affected. No part of these distributions are eligible for rollover, and the 10% early distribution penalty will not apply. Make sure to complete the distributions by 4/15. Otherwise, the Roth excess will become subject to tax in the year distributed and since it was already post tax, this will result in double taxation of the Roth excess.
Permalink Submitted by Lawrence Friedrichs on Fri, 2021-02-05 00:07
“The earnings calculation ends on 12/31/2020″What happens to earnings between 1/1/2021 and the date of distribution?
Permalink Submitted by Alan - IRA critic on Fri, 2021-02-05 00:22
Nothing. That interval is known as the “gap period”. Whatever gain or loss on the excess deferral during the gap period is ignored when returning the excess with earnings by 4/15. If there is a gain, the gain is retained in the plan.
Permalink Submitted by William Tuttle on Fri, 2021-02-05 02:24
While it might just seem like semantics. The taxpayer only has a single one-participant 401k plan with traditional and designated Roth accounts.
You need to clarify the following:
Were all of the contributions employee deferrals?
Was the taxpayer >= age 50 at any time during the 2020 tax year?
Was the taxpayer self-employed or an S-Corp 2% shareholder-employee?
What was the taxpayer’s compensation?
Self-employed: net earnings from self-employment (self-employed earned income) = business profit – 1/2 SE tax.
S-Corp: W-2 Box 1.
This matters because if the taypayer was self-employed, >= age 50 at anytime in 2020 and to the degree self-employed earned income is > $26K. They could allocate:
$19,000 to employee deferrals.
$6,500 to catch-up contributions.
Up to $9,000 in employer contributions = self-employed earned income * 20%.
With self-employed earned income >= $45,000, there would be no excess contributions.
Note: For entirely different reasons, the employee deferrals are quite likely non-compliant if $35K was deposited before the taxpayer had $35K in compensation.
Employee deferrals are not like IRA contributions that can be made on the first business’s day of the year as long as the required compensation is received for the year.
Employee deferrals can not be deposited before the compensation (self-employed income) is received.
Permalink Submitted by Lawrence Friedrichs on Fri, 2021-02-05 18:08
Thanks for the response.The taxpayer is a Schedule C and over 50. Net earnings from self-employment is $81,544 after reduction for 1/2 SE tax.Isn’t the employee deferral $19,500 for 2020 (you stated $19,000)? with $6500 catch-up for a $26K total?Assuming $35K was earned prior to date of contribution (good to know), the $9K excess was contributed to the designated Roth account at TD Ameritrade. Can (or should) the $9K plus earnings (up to December 31) be transferred to the traditional solo 401K account in 2021 and prior to April 15?This would have been cleaner if done prior to 1/1/2021 but does this make a difference?Is there some authority or reference material that discusses this circumstance and the proper fix/timing? Your input seems to contradict Alan-iracritic.In the absence of authority, I am inclined to advise the taxpayer that the $9K plus earnings be withdrawn and the tax on earnings be paid in 2021.Further, it is my conclusion that since this is a single one-participant 401k plan the overall maximum contribution (as computed assuming 100% of 2020 contributions were made to the traditional account) could be made to a combination of the Roth and the traditional. As an example, if $26K has been contributed to the Roth and the maximum allowed is $46K based on requisite net earnings, this taxpayer could still contribute $20K to the traditional account for 2020 and take this $20K as an allowable 2020 deduction. And if the $9K plus earnings can simply be transferred to the traditional account, another 11K could be contributed for 2020. Yes?Thanks again
Permalink Submitted by William Tuttle on Fri, 2021-02-05 20:23
I failed to account for the fact that the entire $35K employee deferral was made to the designated Roth account.
Once a Roth contribution is made it can not be changed. In this case it is an excess deferral, that must be removed as indicated by Alan.
If on the other hand it was a traditional contribution and assuming there was available contribution space. Many one-participant providers will allow a self-employed individual to reallocate any pre-tax traditional deferrals to pre-tax employer contributions and vice versa. The plan sponsor (the employer) has the ultimate responsibility for tracking this.
The fact there is an excess Roth deferral does not preclude the taxpayer from making maximum employer contribution of 20% of their self-employed earned income.
Note: I am not a professional, but I believe the early deferral deposit would be considered an insignificant operational error. It should be self-correctable by placing procedures in place to prevent a reoccurrence, promise not to do it again and document these steps in the plan records.