non-deductible Traditional IRA transferred to Self-Directed Solo 401k

Submitted by Thomas Kwan on Tue, 2017-05-09 05:26

Want to get some opinions on this particular case.

In 2015, I have setup a self-directed Solo 401k (i am the administrator and participant) and was under the impression that traditional IRA funds can be rolled over to the 401k. I had around $10,000 non-deductible basis stated in my 8606 form. My IRA then had around $20,000. I rolled over $15,000 to the Solo 401k.The Solo also have funds from other Rollover IRAs. Since then I have done some stock trading with the funds in the Solo.

I did not learn that non-deductible portion cannot be transferred until early 2017. I want to see what will be the possible ways to fix the mistake.



Submitted by William Tuttle on Tue, 2017-05-09 14:17

  • Can you clarify “self-directed”, because most mainstream one-participant 401k providers default to the participant being the administrator and some even default to the participant as the trustee. Is this a plan where you have “checkbook control” and can invest in any legal asset?
  • I am not a retirement plans professional, but this is what I believe basically must be done. Alan will probably have more detail.
  • Regardless of the 401k plan type this was a 401k plan error and must be corrected by the plan administrator. I do not see this fact pattern in the IRS fix-it guide, but I believe the following two steps must be accomplished.
  • This will need to be corrected by the IRS Employee Plans Compliance Resolution System (EPCRS). However, I believe this is eligible for the  Self-Correction Program (SCP) with no IRS interaction or fee. 
  • The non-deductible basis and associated earnings must be rolled out of the plan, preferably to a traditional IRA.
  • This is the most important aspect. The 1099-R must be properly coded to indicate that this is an EPCRS distribution to avoid penalties and taxes.
  • Will your self-directed “custodian” perform these actions for you or will you have to do them yourself? I personally would consult a professional if you need to do it yourself.

Submitted by Thomas Kwan on Tue, 2017-05-09 17:38

spiritrider, thanks for taking time to answer. Really appreciate that.

  • My solo 401k is a non-prototype plan and I am my own administrator for the solo 401k. So I am the administrator who approves transactions.
  • The associated earnings will be tricky to calculate. i wonder if it is reasonable to calculate the earnings by finding the difference between the account  balance (i got multiple accounts) in 2015, and in 2017 and rollback part of difference (gain) as well.

Submitted by William Tuttle on Tue, 2017-05-09 18:08

I believe there is specific IRS Guidance on calculating the earnings. I do not know the details of that.

Submitted by Alan - IRA critic on Tue, 2017-05-09 18:21

  • First, you need to know the exact amount of the IRA basis you rolled into the solo K. For example, if the value of all your non Roth IRAs on the date of the rollover was 20k (10k pre tax and 10k of IRA basis) and you rolled over 15k, then the amount of basis rolled over in error was 5k. However, if the total IRA value was more than 20k, then you rolled in less basis or if the total value was less than 20k you rolled in more basis. Once you determine the amount of basis that was rolled to the solo K you, then you can also need to determine what the earnings amounted to on the excess amount for the time it was in the solo K. You would then distribute the excess amount plus earnings. You might use the IRA formula here to calculate the earnings:   http://retirementdictionary.com/definitions/netincomeattributablenia
  • EPCRS does not appear to provide guidance specifically dealing with excess amounts ROLLED into the plan rather than those contributed directly. The solution of distributing the excess plus earnings back out of the plan has been suggested in other IRS guidance such as RR 2014-9. 1099R coding of E would probably work, but since the IRA basis was an excess amount to the solo K it would not be rollover eligible when coming out, meaning that you would be taxed on the earnings distributed from the solo K.
  • You indicated you had multiple accounts in 2015. Not sure what those accounts were, but if you had other non Roth IRAs, then you probably had enough total pre tax amounts to have avoided rolling in any IRA basis to the solo. Remember, all your non Roth IRAs are considered as one combined account for basis purposes because your IRA basis is not locked to the IRA account to which you made the non deductible contributions.

Submitted by Reuven Kishon on Wed, 2020-01-22 05:57

Alan,I hope you still get notifications on old threads as I’m in the a very similar situation as the original poster and I’m ready to rectify the problem via the SCP route within EPCRS. Is this a route I can take? Read on below to help answer this question.  One difference between he and I is my solo 401k is for a sole proprietorship that my wife and I are part of. Another difference is that my wife and I have only ever contributed to non-deductible IRAs, so we don’t have to concern ourselves with how much of our rolled over funds were from deductible funds and how much were from non-deductible funds. Yet another difference is that both my wife and I rolled over IRA funds into the solo 401k when we first created it in july of 2018. Her funds went into a sub account with the solo 401k bank account, and mine went into another sub account to help segregate them. I understand that I cannot just roll both of our non-deductible IRA basis out of the solo 401k and into IRAs for each of us, and instead I need to take it as a distribution, which means we get taxed on any earnings that were made off that basis. But when I take the distribution can it be distributed into an IRA anyway or must it go back into a bank account I have control over? I’m also assuming I need to fill out and send to the IRS a form 1099-R  that I would issue from my solo 401k. I’m wondering how I would go about filling it out. I think it would simply be: Box 1: Total distribution (basis + earnings off said basis) Box 2: Earnings made off the basis Box 3: Same value as Box 2? Box 4: Use whatever my marginal tax rate is in 2020 (or the year in which i made the erroneous contributions — in this case 2018) and apply that to the values in box 2 and 3? Box 7:  Code E? Do I check the checkbox right next to this box (the one that says IRA/SEP/Simple)? Box 12: Should I withhold any state tax as well? If so should I use the marginal tax rate of 2020 or 2018? Boxes 13-17: Not sure if I need to enter anything there The Payer’s name would be the solo 401k and the payee would be me, so i’m not too concerned about getting that wrong. Lastly, would we need to issue two 1099-R’s (one for my wife’s distribution and one for mine, or can we take care of it at once with just one 1099-R?) Thanks! 

Submitted by Thomas Kwan on Wed, 2017-05-10 00:55

Alan, thanks for your generous time and answer.I am also reading this IRA article which states that it is ok to have pre-tax and after-tax (non-deductible if I understand it correct) together in the same account – https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans” If your account balance contains both pretax and after-tax amounts, any distribution will generally include a pro rata share of both.”I am pondering if it is ok to leave the non-deductible in the solo 401k and just deal with the issue when i need to distribute.From this chart https://www.irs.gov/pub/irs-tege/rollover_chart.pdf, looks like it is not advisable to rollover from traditional IRA to Solo 401k (QRP) with after-tax money. Probably it is just better to revert the mistake than leaving the after-tax money in QRP. thanks

Submitted by David Wind on Tue, 2017-05-16 16:05

From this chart https://www.irs.gov/pub/irs-tege/rollover_chart.pdf, looks like it is not advisable to rollover from traditional IRA to Solo 401k (QRP) with after-tax money. 

Where does it indicate that on that chart?  I think you’re probably right that it isn’t allowed, but I don’t see where that is specified on that chart.  Actually, I wonder why it doesn’t seem to be mentioned on their rollover chart.

Submitted by Alan - IRA critic on Wed, 2017-05-17 00:07

You are exactly right. The chart has a major flaw and you just described it. They IRA needs to update it with the appropriate footnote.

Submitted by Alan - IRA critic on Wed, 2017-05-10 01:33

The article explains the IRS Notice regarding isolating the after tax amounts by doing a split rollover. But those are after tax amounts in a 401k or other plan that were legally contributed to the plan. IRA after tax amounts are not permissible rollovers to a 401k plan. Up to recently, it was feared that a plan could be disqualified if this happened and that is why several 401k plans will not even accept IRA rollovers, or limit them to rollover IRA accounts which are much less likely to hold any after tax amounts. Presently, it is not clear what position the IRS would take if they became aware of after tax contributions from an IRA knowingly being retained in the 401k rather than being removed with earnings. While the plan is not likely to be disqualified (taxable distribution), there is the possibility of fines and/or excise taxes that grow by the year plus interest. Therefore, you should remove the IRA basis from the 401k with earnings once you determine the correct amount of basis included in that rollover. I take it that you did not have additional non Roth IRA accounts when you did the rollover to the 401k, as that would make it likely that you do not even have a problem.

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