“I’m a wealth advisor working with sole proprietor who wants to set up a 401(k) plan for 2022. Is that still possible and could she make salary deferrals for 2022?”
Highlights of the Discussion
Because this question deals with specific tax information, business owners and other taxpayers should always seek the guidance of their tax professionals for advice on their specific situations. What follows is general information based on IRS guidance and does not represent tax or legal advice and is for informational purposes only.
With respect to setting up a plan for 2022, the short answer is, yes, provided your client has an extension to file her 2022 tax return. However, she could only make an employer contribution for herself—not employee salary deferrals for 2022. Here’s why.
Under the SECURE Act 1.0, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline. Please see a prior Case of the Week, “Plan Establishment and Compensation,” for more detailed information.
For example, a sole proprietorship [or limited liability corporation (LLC) taxed as sole proprietorship] would have an extended plan establishment deadline of October 15, 2023, to set up a plan for 2022. That means your client could set up a 401(k) plan up until that date if she has a tax filing extension.
Regarding the ability to make retro-active employee salary deferrals, unfortunately, it is too late for your client to make salary deferrals for 2022. The change that allows sole proprietors or single member LLCs to make retroactive first-year elective deferrals under Section 317 of SECURE Act 2.0 takes effect for plan years beginning after December 29, 2022. Consequently, if she sets up a 401(k) plan now, she could only make salary deferrals on a prospective basis.
SECURE Acts 1.0 and 2.0 have made favorable changes to plan establishment and funding rules, including the ability to make retroactive first-year elective deferrals for certain unincorporated business owners beginning for the 2023 plan year. Before jumping into a plan, be aware there are lots of details that investors should discuss with their tax and legal advisors.