Overfunded Solo 401k
Hello,
We have a client that has overfunded his Solo 401k for tax year 2021. He likes to fund his Solo 401k when he has the cash available to do a lump sum contribution and because of that, he overfunded in 2018 requiring us to reallocate the overcontribution to 2019 which spilled over to future contributions as he continued to put in lump sums…meaning he’s been contributing “blind” to his Solo 401k (before knowing his earnings). Even though he knows the risk of overfunding, it’s never been a problem because he’s made similar income each year. For tax year 2021, he’s eligible to contribute a lot less, hence the overcontribution issue now. These are his past contributions to his Solo 401k:
$54,267 for 2017
$61,000 for 2018
$54,733 for 2019
$59,667 for 2020
$49,799 for 2021
His CPA just confirmed that he’s eligible to put in $35,725 for 2021. Therefore, he’s overcontributed $14,074 for 2021. We still have time to pull this excess out (before 4/15/22), but my question is in how I calculate the earnings and also the year in which he reports this income?
The money has been sitting in cash so I assumed the earnings would be $0 but Schwab said there’s a calculation (that they won’t perform) to determine the earnings even if it was sitting in cash.
I thought he’d report the excess $14,074 and earnings (if any) on his 2022 tax return but I’m reading through the IRS website and it looks like he might have to report it on 2021 and 2022 tax returns?
He’s 67 so I’m not worried about an early withdrawal penalty. He has an EIN solely for the Solo 401k and operates as a sole proprietor. Thanks for your help.
Permalink Submitted by William Tuttle on Thu, 2022-03-31 14:24
A major 401k plan compliance requirement may have been violated repeatedly if these excess lump sum contributions were made during the tax year.
You can only reallocate 401k excess employer contributions to the following year if they are in fact deposited in the following year by the tax filing deadline including extensions and there is sufficient available employer contribution space for that year.
While it is relatively easy to return excess employee deferrals and earnings. You can not return excess 401k employer contributions made during the tax year. They must be reported on Form 5330 as non-deductible contributions subject to a 10% excise tax penalty on the balance.
The balance will remain and increase with any additional excess contributions in later years. Unless there is available employer contribution space and Form 5330 is filed each year until the balance is $0.
If the 401k participant’s balance is distributable (I. e. >= age 59 1/2), the non-deductible balance can be distributed and reconciled on a final Form 5330.
In any of these years only the allowed employer contributions should be/have been deducted.
A one-participant 401k is not like an IRA, but just with larger contribution limit. It is a full-fledged 401k plan subject to the vast majority of the same laws, rules and regulations.
If in fact these were current tax year excess employer contributions reallocated to the following year without filing Form 5330 and paying the 10% excise tax penalty. These are repeated serious 401k compliance errors.
There is no statute of limitations (SOL) on failure to file Form 5330.
These would have to be filed and reported under the IRS Employee Plans Compliance Resolution System (EPCRS). With repeated compliance errors and > two (2) years since the first error. The client will not be able to use the Self-Correction Program (SCP) without contacting the IRS or paying a fee. They will have to pay a fee for a Voluntary Correction Program submission and approval.
This is not something the vast majority of CPAs can/should do. This requires the services of a professional third party administrator (TPA) or ERISA lawyer.
Failure to correct these 401k compliance errors could result in the disqualification of the one-participant 401k plan. Which could result in the forced distribution of the entire plan balance.
P.S. Given the size of these contributions. Please say that Form 5500-EZ was filed by 7/31 if/when the one-participant 401k plan year-end balance was > $250K.
Late/failure to file Form 5500-EZ after 12/31/2019 are subject to a $250/day penalty up to a maximum of $150K. Although, there is a penalty waiver program that can reduce that to $500/year to a maximum of $1500.