Accidently rolled over what I think were non-deductible IRA funds to my wife and I’s solo 401k

Submitted by Reuven Kishon on Wed, 2020-01-22 06:24

Hey there,

I saw a post that was similar to my situation and I responded to it, but in the case that the original post was too old I figured I’d explain my situation here in a brand new post. Here’s the old post I was referring too, along with my response to it; https://irahelp.com/forum-post/28835-non-deductible-traditional-ira-transferred-self-directed-solo-401k#comment-61594

So my situation is I opened up a solo 401k in July of 2018 for a sole proprietorship that my wife and I are owners of. We then almost immediately rolled over IRA funds from both of our IRAs at the time.

My funds that were rolled over were all non-deductible (although I forgot to claim them as such on our 2018 return — i’ll be rectifying this via an amended Form 8606 if i get confirmation here that these were in fact non-deductible).

My wife’s funds that were rolled over (8.5k to be exact) were partially deductible (3K worth) and partially non-deductible (5.5K worth). Just like in my case, we forgot to claim her 5.5K as non-deductible and will be rectifying this via an amended Form 8606 if I determine that they were in fact non-deductible).

So out of this I have two high level questions:

1. Were my rolled over IRA funds in fact non-deductible, and was my wife’s 5.5K also nondeductible?
2. If the answer to both question in question #1 are yes, then how do I go about getting those funds out of the solo 401k?

To help determine the answer to question #1:

1. Previous to 2018 neither my wife nor I had ever opened up any traditional IRA accounts.
2. In April of 2018 my wife opened her first traditional IRA ever through Schwab, and made a 2017 contribution of $3000 that was deductible (which she deducted on her 2017 return).
2. In July of 2018 my wife contributed $5500 (for tax year 2018) to that same IRA.
3. In July of 2018 I opened my first traditional IRA ever through TDAmeritrade and contributed $5500.
4. In July of 2018 my wife rolled over all $8500 of her traditional IRA funds into our Solo 401k
5. In July of 2018 I rolled over the all $5500 of my traditional IRA funds into our Solo 401k.
6. Our MAGI was 206,000 in 2018
7. My wife contributed to her employer sponsored plan in 2018
8. I did not contribute to an employer sponsored plan in 2018
9. We filed a joint return in 2018 as we got married in June 2018.

Regarding question #2:

Is it true that I should follow the SCP option within the EPCRS? If yes would that entail filling out just one 1099-R (or two, one for my wife and one for me?) and mailing it to the IRS along with a check for tax on any earnings that were made on the basis we rolled into the solo 401k?

As far as filling out the 1099-R, would I do it as follows?

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



Submitted by Alan - IRA critic on Wed, 2020-01-22 21:50

  • Be sure the 206k MAGI is correct for TIRA purposes, because it is just above the phase out range. If correct, then neither of you qualify for an IRA deduction for 2018, because at least one of you (spouse) was a participant in a workplace retirement plan that year. That means the 2018 contributions are non deductible and should have been reported as such on Form 8606. Since you filed jointly for 2018, the tax program used should have indicated that and not applied a deduction.
  • That means 5500 of IRA basis for each of you was rolled into the solo K.
  • Comments made in the other related post still hold true. Unfortunately, the IRS has still not clarified the corrective mechanism for excess amounts (IRA basis) to be removed by the plan. You can probably use the SCP option, but it’s possible the IRS might think otherwise. 
  • Hopefully, you qualify to open the solo K. You cannot just open one to receive IRA rollovers to do back door Roth conversions. The following point is copied from a post by spiritrider to another taxpayer and this question would affect what needs to be done with respect to the IRA basis in the solo K:
    • First, to be considered engaged in a trade or business, you must have a good faith intention to make a profit or with the belief that a profit can be made from considerable, regular, and continuous activity.
    • Then as pointed out by Alan, in order to be considered a self-employed individual under Section 401(c) to be eligible to adopt a one-participant 401k. You must further have self-employed earned income from a trade or business in the current or any prior year.
    • Finally:
    • An IRA custodian is not responsible for verifying you have sufficient compensation and a MAGI <= the applicable limit.
    • An HSA custodian is not responsible for verifying you are covered by an HDHP and have no disqualifying “other coverage”.
    • Just like a one-participant 401k provider is not responsible for verifying you are a “self-employed individual” as defined in Section 401(c) eligible to adopt the plan.
    • In all these cases. The eligibility to open accounts and make contributions is between you, the tax code and the IRS.
  • While I have not heard of this happening. Keep in mind that in the worst case disqualification scenario. The IRS could force you to distribute all one-participant 401k account balances including any rollovers. They would not be rollover eligible, subject to ordinary income taxes and if applicable, the 10% early withdrawal penalty.
  • If you are going to do this. Find yourselves some legitimate self-employment. Drive an Uber, do some independent contractor work, make something and sell it on Etsy, etc…

Submitted by Reuven Kishon on Wed, 2020-01-22 22:42

It seems that it doesn’t respect newlines when posting replies…

Submitted by Reuven Kishon on Wed, 2020-01-22 22:41

  • I’m sure the MAGI is 206K, and keep in mind that this is for tax year 2018 which has lower limits than tax year 2019.
  • We did not report the IRA contributions as non-deductible so we will need to amend form 8606 (I know how to take care of that) .
  • We do qualify for the solo 401k. We made self employment income in 2018 and 2019 (albeit very little, like in the hundreds of dollars) . We were hoping that was sufficient to avoid disqualification.
  • Now I am wondering:
  1. How do we know if we can use the SCP option or not? If they haven’t clarified things then it’s a gamble, no? Would they write back to us letting us know (once they receive our 1099-R with payment of tax on earnings?)
  2. Once we take a distribution from the solo 401k for the basis + earnings, is it sufficient to send a 1099-R to the IRS (along with a check for the tax on the earnings) in order to be in compliance? And is it safe to use the marignal tax rate for the year within which we made the mistake (2018), or should we use the year in which we rectify the situation (2020)?
  3. How to fill out the 1099-R appropriately? Please see the comments/questions I posted about the various boxes on the form. I’ve copied them here:
  • 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

Thank you so much!!

Submitted by Alan - IRA critic on Thu, 2020-01-23 03:48

  • OK, sounds like your solo K is safe. As for the SCP, we are lacking the info or knowledge of EPCRS to state that you can use the SCP with certainty. But we do know that RR 2014-9 clearly indicates that the solution is to distribute the IRA basis amount back to the employees with allocated earnings. I think any sensible method you come up with to calculate the earnings will be fine, and also think that this is the type of infraction that the SCP is intended to address. You could always call EPCRS and ask them.
  •  Assuming that the 1099R would use code E (EPCRS distribution) and earnings were 200, the 1099R for each spouse would show  5700 in Box 1;  200 in 2a; 5500 in 5; E in 7, and that’s it other than the ID boxes. No withholding.
  • No special tax payment – just include this with your tax return.

Submitted by Reuven Kishon on Thu, 2020-01-23 06:14

  • When you say “no special tax payment – just include this with your tax return”, are you saying that I do not need to send any payment of tax on the earnings I withdraw, when I send a copy of the 1099R’s to the IRS? That instead I should just include the tax on the earnings somewhere in my return for the year in which i take the distribution? If so, where would i report this tax? On some line in the 1040? Or on another form / schedule?
  • FYI, according to the distribution instructions I was given by the company that helped me set up the solo 401k, they say I should do the following upon a distribution:
  1. Withhold 20% and send it to the Treasury Dept. by the 15th day of the month following the distribution.
  2. Complete a Form 945 to report the 20% withholding by January 31 of the following tax year in which the distribution was made.
  3. Complete a and file a 1099-R from the 401(k) to you by February 28 .
  4. Report the distribution on your 1040 by April 15 .

Submitted by Alan - IRA critic on Thu, 2020-01-23 14:47

  1. The 1099R will be reported on lines 5a and 5b of Form 1040. The 20% withhholding is for eligible rollover distributions, which the plan assumed this was. But it isn’t an ERD, so no withholding required. The earnings will not be significant income compared to the rest of your income. 1099R Inst. do not indicate any withholding in Box 4 for an E coded distribution.
  2.  Their steps 3 and 4 are correct, but not 1 and 2.
  3.  Of course, since this is not an ERD, you cannot roll it over back to your IRAs, and the IRAs no longer have any basis unless you have made more non deductible contributions since 2018. You can still do back door Roths from your IRAs with little or no tax due since the bulk of your pre tax balances are now in the solo Ks.

Submitted by Reuven Kishon on Thu, 2020-01-23 18:05

I think you meant 1099 to be reported on lines 4a and 4b, but thank you! I think I have what I need now 🙂

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