Questions about solo 401k and adding myself as spouse

[johnworkman01]

My wife is starting a job as a part-time, 1099 therapist. We do not need her income for living expenses, so the goal is optimize tax savings and the amount that goes into retirement accounts.

Her annual net earnings from self-employment (profit minus the deduction for half of SE tax) will be around $70,000. This will be her only income. I plan to elect taxation as a pass-through entity (but am open to alternatives). I plan to use mysolo401k.net to set up a solo 401k for her that allows the mega backdoor Roth. I found this post particularly helpful: https://www.whitecoatinvestor.com/fo...-backdoor-roth

Using IRS Publication 560 or Mike Piper's calculator, the contributions she can make (using 2020 numbers) are:
-$19,500 pre-tax employee contribution
-$13,940 pre-tax employer profit-sharing contribution
-Is she then allowed to make voluntary after-tax contributions (and subsequently do an in-service Roth conversion) equal to $57,000 - $19,500 - $13,940 = $23,560?

I am also considering if and how I should include myself as a spouse. I am a high-income W2 employee. I max out my 401k at my day job. I will legitimately be keeping the books for her business and completing her (our) taxes. Any earnings attributed to me (and not her) would save on SS tax, as I will be above the SS income cap from my day job.

The owner of the practice requires each therapist to create an LLC, and the owner pays the LLC. (I believe this is a misunderstanding on her part of what an LLC does, but all the other therapists in the practice have done it for years, it wasn't up for discussion, that ship has sailed). So, a QJV isn't an option. We live in Virginia, not a community property state. We could list both our names as owners of the LLC. Or I could make myself an employee, although that seems to be a real hassle based on my reading. What additional retirement contributions could we make if I were earning income from the LLC business? The $13,940 employer contribution would not change, correct? It would just be split between us, which doesn't help. Could I make additional mega backdoor Roth contributions using my $57,000 limit? Thanks for any thoughts.

[jacoavlu]

use Harry Sit’s spreadsheet instead, use the unincorporated tab. Plug in numbers, adjust profit sharing percent from 0-25, see what happens

come back with questions

[johnworkman01]

Yes, I've played around with TFB's calculator, and it left me a little confused. I understand the calculation for maximum profit-sharing contribution; I looked at Pub 560 to figure it out.

TFB's calculator shows that each profit sharing dollar reduces the total possible contribution. For example, with 0% profit-sharing, the output is $19,500 employee and $37,500 after-tax, as you'd expect. But with 25% profit-sharing, the output is $19,500 employee, $13,940 profit sharing, and $22,321 after-tax. For a total of $55,761, not $57,000.

I can't figure out why the total goes down with more profit-sharing. I can't find the official IRS formula. If anyone can point me to the appropriate IRS reg, I'd appreciate it.

[jacoavlu]

TFBs calculator is correct and is the only one that will give you the accurate answer with interplay of deferral, profit sharing, and voluntary after tax

spiritrider can more elegantly answer but the bottom line is that it's true, when overall numbers are below the annual addition limit, increasing profit sharing one dollar reduces voluntary after tax contribution by two dollars. If income is higher it doesn't matter but your hypothetical of $70,000 happens to fall in the range where it does matter, and you may choose to reduce profit sharing percent, to achieve the result of overall greater dollars into the plan

I think it can be explained by the fact that profit sharing contributions are a deduction for the entity reducing profit, while also reducing employee compensation, which results in a 2x factor in the formula

[spiritrider]

jacoavlu and TFB's spreadsheet are correct.

• The annual addition limit is the lessor of the dollar limit (2020 = $57K) or 100% of compensation.
• Self-employed employer contributions are not compensation and reduce both compensation and if compensation is < the dollar limit, the annual addition limit.
• IRS publication 560 or any other IRS rules, regulations or publications do not explicitly demonstrate how to calculate maximum employee after-tax contributions when there are self-employed employer contributions. Pub 560 does show you the effect of employer contributions reducing compensation on steps 8-15, especially step 11.
• Self-employed maximum employee after-tax contributions is the lessor of:
  • $57K - 403b annual additions - one participant (employee deferrals + employer contributions)
  • (Business profit - 1/2 SE tax) - one participant (employee deferrals + (employer contributions * 2).
• To my knowledge TFB's spreadsheet is the only place online to correctly calculate the effect of 403b annual additions and employee after-tax contributions.

Not a single one of the online purveyors of the so-called Mega Backdoor Roth enabled one-participant 401k has a calculator or even acknowledges the interplay of employer contributions and the annual addition limit. This is why I am not in favor of any inexperienced one-participant 401k plan sponsor using these websites. When they should be using a professional TPA. There is going to be rampant 401k plan compliance errors.

[Larry Ragman]

On the second question (how you can be paid by the LLC and the impact on retirement plan contributions), I’ll take a crack just to pull through the question. First, both you and the LLC will owe self employment tax on your compensation whether or not you are an employee or owner of the LLC. Though you get a break on SS if you are maxed out from w2 employment. Second, if you set up a solo 401k for this extra income, there will be an interplay with your work 401k for your own $57k total. You would be better off, I think, doing a mega backdoor Roth at your w-2 job if the plan there allows.

[spiritrider]

if you set up a solo 401k for this extra income, there will be an interplay with your work 401k for your own $57k total. You would be better off, I think, doing a mega backdoor Roth at your w-2 job if the plan there allows.

There is only one employee deferral limit (2020 = $19.5K) across all 401k, 403b and SIMPLE IRA plans. If an individual has reached that limit with other such plans, they can not make deferrals to a one-participant 401k.

There is a separate annual addition limit (2020 = $57K) for each unaffiliated employer. In most cases there is no affiliation unless the individual is a 403b participant or is in a controlled or affiliated service group.

[Larry Ragman]

There is only one employee deferral limit (2020 = $19.5K) across all 401k, 403b and SIMPLE IRA plans. If an individual has reached that limit with other such plans, they can not make deferrals to a one-participant 401k.

There is a separate annual addition limit (2020 = $57K) for each unaffiliated employer. In most cases there is no affiliation unless the individual is a 403b participant or is in a controlled or affiliated service group.

Thank you for the helpful clarification. Now, about that separate $57k limit for the OP in the circumstances described: from your previous answer I inferred it would be limited by his compensation if he was an owner of the LLC. But would he get the full $57K if an employee? If so, it might be worth the self employment tax if he could get that much into the solo 401k after tax and converted to Roth.

[jacoavlu]

the annual addition limit for each unaffiliated employer is the same regardless of entity structure. And additions are always limited by compensation whether an employee, partner, or shareholder-employee.

People try to get too cute, I would not recommend making the situation more complex and trying to get OP as an employee or partner in spouses LLC and solo 401k.

OP if you pursue a mega backdoor Roth plan I would recommend using employee fiduciary.

[johnworkman01]

jacoavlu and TFB's spreadsheet are correct.
Not a single one of the online purveyors of the so-called Mega Backdoor Roth enabled one-participant 401k has a calculator or even acknowledges the interplay of employer contributions and the annual addition limit. This is why I am not in favor of any inexperienced one-participant 401k plan sponsor using these websites. When they should be using a professional TPA. There is going to be rampant 401k plan compliance errors.

spiritrider This is sobering advice. I must admit I was getting more nervous the more I read. Any TPAs you hear good things about, for solo 401ks and mega backdoor Roths?

jacoavlu I see your recommendation for Employee Fiduciary, thank you. Do you use them?

[johnworkman01]

jacoavlu and TFB's spreadsheet are correct.

• IRS publication 560 or any other IRS rules, regulations or publications do not explicitly demonstrate how to calculate maximum employee after-tax contributions when there are self-employed employer contributions. Pub 560 does show you the effect of employer contributions reducing compensation on steps 8-15, especially step 11.

On this point, Harry Sit replied to a message (what a saint). Here's the key part of his response:

What's commonly known as the $57,000 limit is really a shorthand for "$57,000 or 100% of the owner's compensation, whichever is less." The same rule that defines $57,000 also has this second part, just like the IRA contribution limit is really "$6,000 or the compensation income, whichever is less." The often ignored second part of the $57,000 limit:
https://www.irs.gov/retirement-plans...ibution-limits


Calculating the compensation for self-employed:
https://www.irs.gov/retirement-plans...-and-deduction


(End Harry's message) If you read those rules in conjunction, it's the clearest rule I've seen. Although, as spiritrider says, it stops short of giving an actual demonstration.

[spiritrider]

Thanks jacoavlu for that link from Harry. That is probably the best and most concise treatment that the IRS has given on this issue. However, I wish they were just a little bit clearer for the uninitiated.

Maybe they assumed that reader would know when they said; "contribution", they were referring to employer contributions and not employee deferrals. It just would have been nice if they prefaced the discussion with saying they were talking about employer contributions only.

Employee (deferrals and after-tax contributions) reduce the remaining annual addition limit, but they do not reduce compensation like employer contributions do.

And, thanks to Harry for taking the time to respond.