Tag Archive for: owner-only

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401(k) Plans for Owner-Only Businesses

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“Can an unincorporated, owner-only business have a 401(k) plan and, if so, are there any special considerations of which we need to be aware?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in North Carolina is representative of a common question related to owner-only businesses and retirement plans.

Highlights of Discussion

  • Yes, an unincorporated, owner-only business may have a 401(k) plan—commonly referred to as a(n) “individual (k)” or “solo (k)” plan.
  • Special considerations with respect to the solo (k) plan include, but would not be limited to, the
    • Deadline for establishing a 401(k) plan,
    • Deadline for making a salary deferral election, and
    • Owner’s compensation for contribution purposes.
  • The deadline for establishing a 401(k) plan for any eligible business changed beginning in 2021 to the business’s tax filing deadline plus applicable extensions.[1] The prior deadline was the last day of the business’s tax year (e.g., December 31 for a calendar year tax year). However, keep in mind the timing of when a salary deferral election must be made has not changed.
  • Salary deferrals can only be made on a prospective basis [Treasury Regulation (Treas. Reg.) 1.401(k)-1(a)(3)]. Therefore, the salary deferral election must be made prior to the receipt of compensation. For self-employed individuals (i.e., sole proprietors and partners), compensation is considered paid on the last day of the business owner’s taxable year. The timing is connected to when the individual’s compensation is “deemed currently available” [see Treas. Reg. § 401(k)-1(a)(6)(iii)]. Therefore, a self-employed person has until the end of his or her taxable year to execute a salary deferral election for the plan (e.g., December 31, 2020, for the 2020 tax year).
  • The definition of compensation for contribution purposes for an unincorporated business owner is unique [IRC 401(c)(2)(A)(I)]. It takes into consideration earned income or net profits from the business which then must be adjusted for self-employment taxes. Please refer to the worksheet for calculating compensation for and contributions to a solo (k) plan for a self-employed individual in Publication 560, Retirement Plans for Small Businesses. A business owner who wants to have a 401(k) plan should work with his or her CPA or tax advisor to determine his or her earned income and maximum contribution for plan purposes.
  • The 2020 contribution for an unincorporated business owner to a solo (k) plan with enough earned income could be as high as $57,000 (or $63,500 if he or she turned age 50 or older before the end of the year). For 2021, those limits are $58,000 and $64,500, respectively.

Example:

Ryan is a sole proprietor who would like to set up a solo k plan effective for 2020.  The IRS extended his tax filing deadline for 2020 to May 17, 2021, and if Ryan files for an extension, his extended tax deadline would be October 15, 2021. Therefore, the latest Ryan could potentially set up a solo k plan for 2020 would be October 15, 2021. Since Ryan is past the deadline for making a salary deferral election for 2020, however, his contribution would be limited to an employer profit sharing contribution based on his adjusted net business income for 2020. The sooner Ryan sets up the solo k for his business, the sooner he will be able to make employee salary deferrals for 2021.

Conclusion

For self-employed individuals and their tax advisors, there are several special considerations with respect to setting up and contributing to solo (k) plans, including, but not limited to, the deadline for establishing a 401(k) plan, the deadline for making a salary deferral election, and the owner’s compensation for contribution purposes.

[1] Section 201 of the Setting Every Community Up for Retirement Enhancement Act of 2020

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Relief for delinquent Form 5500-EZ filers

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“I have several clients who run owner-only businesses that have 401(k) plans that cover themselves and their spouses. I believe at least some of them should have been filing Form 5500-EZ, Annual Return of a One-Participant (Owners/Partners and Their Spouses) Retirement Plan or A Foreign Plan, but have not. Is there a way for them to correct this error without penalty?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Colorado is representative of a common inquiry related to plan reporting requirements.

Highlights of the Discussion

An owner-only business with a qualified retirement plan that covers the owner, partners and spouses, such as a “solo (k)” or “individual (k),” must begin filing an annual Form 5500-EZ when the total value of the plan assets exceeds $250,000 at the end of the plan year. Regardless of plan asset value, an owner-only business must file a Form 5500-EZ to report the final plan year of the plan (See the Instructions for Form 5500-EZ.)

Initially, the IRS did not provide any penalty relief for delinquent Form 5500-EZ filers. That changed with the IRS’s release of Revenue Procedure 2015-32, which made permanent a 2014 pilot program that allowed owner-only businesses to correct late Form 5500-EZ filings. Without the program, a plan sponsor faces late filing penalties of $25 per day, up to $15,000 for each late Form 5500-EZ, plus interest, and $1,000 for each late actuarial report (for a defined benefit plan, if needed).

The IRS’s Form 5500-EZ Later Filer program is separate from the Department of Labor’s Voluntary Fiduciary Correction Program (VFCP), which is available to late filers of Forms 5500, Annual Return/Report of Employee Benefit Plan. Form 5500-EZ filers do not qualify for the VFCP.

In order for late filers of Form 5500-EZ to qualify for penalty relief, the business owner must meet the following criteria. He or she

  1. Has not been informed of a late filing penalty (i.e., the business owner has not received a CP 283 Notice from the IRS);
  2. Submits all delinquent returns for a single plan together;
  3. Prepares a paper Form 5500-EZ for each delinquent year, including any required schedules and attachments, if any. Use the Form 5500-EZ return that applied for the delinquent plan year. However, if the return is delinquent for a year prior to 1990, use the Form 5500-EZ for the current year (see prior year Forms 5500-EZ);
  4. Writes in red letters at the top of each paper return: “Delinquent Return Filed under Rev. Proc. 2015-32, Eligible for Penalty Relief;”
  5. Attaches a completed one-page transmittal schedule (Form 14704) to the front of each late return;
  6. Pays the required fee. The fee is $500 per delinquent return, up to $1,500 per plan. Make checks payable to “United States Treasury;” and
  7. Mails the returns to the following address (Note: Electronically filed delinquent returns are not eligible for penalty relief).

First class mail

Internal Revenue Service

1973 North Rulon White Blvd.

Ogden, UT 84404-0020

Private delivery services

Internal Revenue Submission Processing Center

1973 North Rulon White Blvd.

Ogden, UT 84404

Conclusion

Some owner-only businesses with qualified retirement plans must file an annual Form 5500-EZ. If they fail to do so when required, IRS penalties could result. Since 2015 there has been a permanent penalty relief program for Form 5500-EZ late filers to follow in Revenue Procedure 2015-32.

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