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Real Estate Agents and Retirement Plans

“A client of mine is a real estate agent who receives income that is reported on Form 1099-MISC, Miscellaneous Income. Can this individual contribute to a retirement plan?”

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 Dakota is representative of a common question related plan eligibility.

Highlights of Discussion

• Some unique rules for retirement plan eligibility apply for real estate agents, based on their worker status as a “statutory nonemployee.” (Since each employment scenario is based on unique facts and circumstances; it is recommended that workers seek professional tax advice for a definitive determination in their particular situations.)
• Individuals who perform services for businesses may be classified as an independent contractor, a common law-employee, a statutory employee, or a statutory nonemployee. The IRS explains each classification in more detail in Publication 15-A, Employer’s Supplemental Tax Guide.
• There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Licensed real estate agents include individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.  Direct sellers and real estate agents are treated as self-employed for all Federal tax purposes, including income and employment taxes, if the following are true.

1. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked; and
2. Their services are performed under a written contract that provides they will not be treated as employees for Federal tax purposes.
Because real estate agents are considered self-employed, they are eligible to establish a retirement plan based on their earnings from self-employment. Please see IRS Publication 560, Retirement Plans for Small Businesses.

Conclusion
If a licensed real estate agent meets the above criteria, he or she could establish a retirement plan using his or her Form 1099-MISC income. Since each employment scenario is based on unique facts and circumstances, it is recommended that workers seek professional tax advice for a definitive determination.

 

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401(k) Plans for Owner-Only Businesses

“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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Retirement Plans for Statutory Employees

“One of my business-owner clients employs ‘statutory employees.’ Does the owner have to cover these workers under a retirement plan established for the business?”

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 a financial advisor from New York is representative of a common inquiry related types of employees and retirement plans.

Highlights of the Discussion

  • If the workers have been properly classified as statutory employees [IRC §3121(d)(3)], then your client would not have to cover them under a retirement plan established for the business—as long as the business is not selling life insurance.
  • Generally, statutory employees are independent contractors who meet certain conditions related to Social Security and Medicare taxes, and are
  1. Agent-drivers or commission-drivers,
  2. Full-time life insurance salespersons,
  3. Home workers, and
  4. Traveling or city salespersons.
  • Statutory employees remain independent contractors for employee benefit purposes in the eyes of the IRS. As such, they are not eligible to participate in an employee benefit plan sponsored by the business owner for employees. However, as statutory employees, because the IRS views them as independent contractors, they could establish and maintain their own retirement plans based on their self-employment earnings.
  • The one exception to the above rule is for full-time life insurance salespersons. They are treated as employees not only for Federal Insurance Contribution Act (FICA) tax withholding purposes, but also for certain employee benefit programs maintained by the business [IRC 7701(a)(20)]. As a result, they may participate in the business owner’s qualified deferred compensation or retirement plans under IRC §401(a).  They are also entitled to other employee benefits such as group term life insurance, accident and health plans and cafeteria plans. Note that a full-time life insurance salesperson may not base contributions to a self-employed retirement plan on the compensation received from the insurance business (Part 4, Chapter 23, Section 5 of the Internal Revenue Manual Technical Guidelines for Employment Tax Issues).

Conclusion

An individual who performs services for a business may be classified as 1) an independent contractor, 2) a common law-employee, 3) a statutory employee or 4) a statutory nonemployee. Proper employee classification is critical for tax and employee benefit purposes. Therefore, it is prudent for business owners to seek competent tax guidance when making these determinations. The IRS explains each classification in more detail in Publication 15-A, Employer’s Supplemental Tax Guide.

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Tax Reporting of Retirement Plan Contributions for Unincorporated Businesses

“Tax season has me wondering how sole proprietors deduct contributions they make to their qualified retirement plans?”

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 Oklahoma is representative of a common inquiry related to deducting retirement plan contributions.

Highlights of the Discussion

Unincorporated business owners, such as sole proprietors, farmers and partnerships, are among the IRS’s list of “pass through” business entities. Why the name—because the profits of these firms directly pass through the businesses to their owners, and are taxed on the owners’ individual income tax returns.

Special rules apply for how such businesses report and deduct contributions to their retirement plans for themselves and their employees. The following table provides a general, informational summary of annual tax reporting requirements for unincorporated business owners who make retirement plan contributions. The table is based on the instructions to the filing forms noted. IRS Publication 560, Retirement Plans for Small Businesses provides additional information. Please consult a tax advisor for specific guidance.

Tax Reporting of Retirement Plan Contributions for Unincorporated Businesses

Type of Employer Contributions for Common Law Employees Contributions for the Business Owner
Sole proprietorship Line 19 of 2018 Schedule C, Profit or Loss From Business (attachment to IRS Form 1040)

 

Instructions to Schedule C

 

Line 28 of 2018 Schedule 1, Additional Income and Adjustments to Income,(attachment to IRS Form 1040)

 

Instructions for Schedule 1

 

Farmers Line 23 of 2018 Schedule F, Profit or Loss From Farming, (attachment to IRS Form 1040)

 

Instructions to Schedule F

 

Line 28 of 2018 Schedule 1, Additional Income and Adjustments to Income, (attachment to IRS Form 1040)

 

Instructions for Schedule 1

 

Partnership Line 18 of 2018 Form 1065, U.S. Return of Partnership Income

 

Instructions to Form 1065

 

Box 13 of Schedule K-1 Partner’s Share of Income, Deductions, Credits, etc. (attachment to Form 1065)

 

Instructions for Schedule K-1

 

 

 

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Deferral election timing for the self employed

“Several of my clients are self-employed and have 401(k) plans. What is the date by which a self-employed individual must make his or her salary deferral election?”

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 Nevada is representative of a common inquiry related to 401(k) plan salary deferral elections.

Highlights of the Discussion

Special rules regarding salary deferral elections apply to self-employed individuals (e.g., sole proprietors or partners). They must make their cash or deferred elections no later than the last day of their tax year (e.g., by December 31, 2018, for a 2018 calendar tax year). The timing is connected to when the individual’s compensation is “deemed currently available” [see Treasury Regulation Section (Treas. Reg. §) 1.401(k)-1(a)(6)(iii)].

Often a self-employed individual’s actual compensation for the year is not determined until he or she completes his or her tax return, which, in most cases, is after the end of the partnership or individual’s taxable year. However, the IRS deems a partner’s compensation to be currently available on the last day of the partnership taxable year and a sole proprietor’s compensation to be currently available on the last day of the individual’s taxable year. Therefore, a self-employed individual must make a written election to defer compensation by the last day of the taxable year associated with the partnership or sole proprietorship.

EXAMPLE

A partner can make a cash or deferred election for a year’s compensation any time before (but not after) the last day of the year, even though the partner takes draws against his/her expected share of partnership income throughout the year.

There are also special rules that address when salary deferrals for self-employed individuals are treated as made to the plan (versus when they may actually be made). Treas. Reg. §1.401(k)-2(a)(4)(ii) states that an elective contribution made on behalf of a partner or sole proprietor is treated as allocated to the individual’s plan account as of the last day of the partnership or sole proprietorship’s taxable year.

With respect to the DOL’s deferral deposit deadline, deferrals for self-employed individuals must be deposited as soon as they can be reasonably segregated from the business’s general assets. The DOL’s safe harbor for plans with fewer than 100 employees also applies. Therefore, as long as the deferrals are transmitted within seven business days after the amounts are separated from the business’s assets, the contributions are deemed timely made.

From the IRS’ tax perspective, in no event can the deferrals be deposited after the deadline for filing the business’s tax return, plus extensions.

Conclusion

With respect to making a salary deferral election, a self-employed individual must do so no later than the last day of his or her tax year. The election should be documented in writing for proof in the event the plan later undergoes an audit. Therefore, those self-employed individuals following a calendar tax year must be sure to execute their written deferral elections by December 31, 2018!

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