Solo401k Establishment & Contribution Deadlines

Submitted by Jerry Matecun on Sun, 2024-01-07 16:23

A 30 year-old owns a one-person sole proprietorship with 1099 income. She said the custodian told her that a Solo401k could be established in 2023; and once established she could fund 2022 contributions before her 2022 extended tax filing deadline of 10/16/23. The adoption agreement and the trustee and custodial agreement show an effective date of 1/1/2022 and was signed/executed on 9/13/23. She setup the plan and made a lump sum $15,000 employee deferral in early October 2023. Based on her 2022 Schedule C the max she could have contributed was $34,484 (20,500 deferral + 14,484 profit sharing).

I called the custodian’s retirement department because I think the plan would have needed to be setup by 12/31/22 to make deductions for 2022. Custodian said the rule had changed and the daughter had been told correctly. I’ve read different accounts of how SECURE ACT changed the rules but I haven’t seen this particular issue addressed. I think we have excess contributions but I’m not sure. And if we do, I am not clear if it falls under 1a) or 1b) below, or how it might be treated in this situation.

1. Is 15,000 employee deferral an excess contribution for tax year 2022 or is it good? If it is not good, per IRS 560 p23 (I am not clear on the difference between a) and b):
a) Carryover of Excess Contributions: is the entire 15,000 contribution considered carryover, so it can be deducted for tax year 2023? Or,
b) Excise Tax for Nondeductible (Excess) Contributions: Would this situation be subject to excise tax and filing form 5330.
c) In either a) or b), can the money stay in the account, will 10% excise tax apply, and can the excess contribution be applied to 2023 contribution limits?
d) How are earnings treated in either case?
2. In either case, the CPA would need to amend the 2022 tax return and remove the deduction?
3. Is there potential for double taxation if not resolved before 2023 tax deadline (4/15/24 or is it 10/15/24 with extension)?
4. What else might be needed to remedy this?

Thanks!



Submitted by William Tuttle on Sun, 2024-01-07 19:04

The custodian is not completely correct. Unfortunately, this has become a not uncommon occurrence at the major one-participant 401k providers.

  • First, a review of recent changes to the 401k adoption/contribution deadlines.
  • Prior to 1/1/20, the 401k adoption deadline was 12/31.
  • The original SECURE Act changed the 401k adoption deadline to the businesses tax filing deadline including extensions effective 1/1/20. However, it did not change the requirement that an employee deferral election must be completed by 12/31. Therefore, a 401k adoption after 12/31
  • can not make employee deferrals for the previous tax year.
  • Only employer contributions by the tax filing deadline including extensions can be made for the previous tax year.
  • Realizing the oversite, SECURE Act 2.0 adds the capability for sole proprietors to adopt and make employee deferrals for the first year until their tax filing deadline without extensions effective 12/29/22. IRS guidance is required if/when an employee deferral election is required.
  • Even under new SECURE Act 2.0 change she did not meet the 04/18/23 requirement to make a 2022 employee deferral.
  • However, as long as she did not make an employee deferral to the designated Roth account she has a much more favorable remedy.
  • A one-participant 401k custodian’s contribution type tracking is a service. The custodian does not report this to the IRS. The administrator (your client) actually makes the final determination.
  • As long as the “employee” deferral” was not made to the designated Roth account, she can reclassify that contribution as an employer contribution. Under the original SECURE Act, this contribution is timel.
  • That only leaves $15,000 – $14,484 = $16 in 2022 excess employer contributions.
  • Since there were no excess employer contributions on 12/31/22. All that needs to be done is amend the 2022 tax return to a $14,484 deduction and pay whatever tax might be due. The $16 will automatically be treated as a 2023 contribution.

    • Note: If this was a Roth employee deferral, it was for the 2022 tax year and any excess deferral  would have to be removed by 04/15/23 not 04/15/24. Also, the carryover of excess contributions, 10% excise tax on any non-deductible balance and the filing of Form 5330 only applies to employer contributions. They do no apply to excess employee deferrals. If they are not removed by 04/15, they can only be withdrawn if otherwise distributable and subject to double taxation.

    Submitted by Jerry Matecun on Sun, 2024-01-07 21:42

    Thank you very much. This was super well articulated.  Can you please confirm my understanding:Since this was NOT a ROTH deferral: She can reclassify the employee deferral of $15,000 to an employer contribution for 2022 of $13,984. The balance of $1,016 can be applied toward her 2023 employer contribution.

    • The 2022 amended tax return should change the deduction to $13,984;
    • A 5330 does not need to be filed and there is no excise tax;
    • No distribution needs to occur.  

     Regarding the reclassification:

    • How does she need to document that she reclassifed to employer deduction (the original check for 15,000 said “employee contribution 2022”)? 

     Also, was curious what you meant in this bullet point:Realizing the oversite, SECURE Act 2.0 adds the capability for sole proprietors to adopt and make employee deferrals for the first year until their tax filing deadline without extensions effective 12/29/22. IRS guidance is required if/when an employee deferral election is required.

    • What do you mean by “IRS guidance is required if/when employee deferral election is required?

    Submitted by David Mertz on Sun, 2024-01-07 19:32

    • The new deadline to make the deferral election with respect to  a first-year plan is effective for plan years beginning *after* 2022, so the deadline to make an elective deferral with respect to 2022 compensation was the end of 2022 for all 401(k) plans.
    • “$34,484 (20,500 deferral + 14,484 profit sharing).”  That doesn’t add up.  Either the total should be $34,984 or the maximum employer contribution is $13,984.

    Submitted by William Tuttle on Mon, 2024-01-08 00:13

    • How does she need to document that she reclassifed to employer deduction (the original check for 15,000 said “employee contribution 2022”)?
    • As the administrator of her one-participant 401k plan, she should keep a written record of:
    • any employee deferral elections. Such an election remains in effect unless changed
    • The amount of any traditional or Roth deferrals for each year
    • The amount of any employer contributions for each year
    • If the plan supports employee after-tax contributions, any such contributions each year.
    • Any traditional employee deferrals and employer contributions are combined and deducted on Form 1040 Schedule 1, Line 16
    • Any year the plan balance is  > $250K, a Form 5500-EZ must must be filed by the following 7/31.
  • What do you mean by “IRS guidance is required if/when employee deferral election is required?
  • While this does not apply to your client. This SECURE Act 2.0 change also did not add any legislative text addressing the employee deferral election in these circumstances. IRS guidance will be necessary.
    • It is unlikely that no employee deferral election is required.
    • An employee deferral election could be required before any deferral.
    • An employee deferral election could be required by the tax filing deadline without extensions.

    Submitted by Jerry Matecun on Mon, 2024-01-08 16:50

    Spirit rider. Thank you once again. A final question:if she reclassifies her employee deferral to an employer contribution. Should she just have in her file something that says to effect: the custodian said I could contribute for 2022. Once I discovered that under Secure Act we could only contribute employer contributions, I reclassified the employee deferral to employer contribution. And then my CPA amended my tax return…..etc.   Is there a place on IRS website that details this issue? 

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