Strange Question from Customer Service Person

[blbaker28]

Hello everyone, I've been busy trying to get my TIRA moved into a solo 401k. My TIRA is with fidelity. They have a 'self-employed' 401 option that I think would work for the reasons of this switch (i.e. avoiding the pro-rate rules when I try to do a back door roth conversion). As we were going through the paperwork she said to and ask me "The purpose of this account is to make contributions, you are planning on contributing to it aren't you?" I thought this was a little nosy and really none of her business. However, it got me wondering if I hadn't said something like "eventually I hope to" would I have heard something about some rules or something I'm missing. Are there contribution requirements into a solo 401? If I move the TIRA funds into the self-employed 401 without making any other contributions will that be a problem or am I breaking any rules?

As always, I appreciate the help

b

[JBME]

you need to be legitimately self-employed to open a person/i-401k account. The question was not nosy. You can't just open a 401k account because your work doesn't have one (not your case) and you need to get a $0 balance in an IRA to do the backdoor Roth IRA

[blbaker28]

Thank you JBME, how do you define legitimately self-employed? I have a legitimate LLC that does real business. Is that not enough? It's not overwhelming business and I can't pay my expenses with it but I haven't found anything that says your personal company has to have a certain revenue number, or make any minimum contributions to your small business 401k plan. I did see something that says if you open it and don't fund it, the IRS might start asking questions but if I fund it with my TIRA, I was under the impression that was legal and completely legitmate. A loophole? Maybe, but I'm not concerned with the moral ambiguity of it all, I'm most concerned with the legality of it. As we all know the morality of something and its legal status are often not consistent with one another.

[Tim]

https://www.irs.gov/retirement-plans...ant-401k-plans

I believe you have to have had self employed or 1099 earned income previously. That would have been eligible for a contribution . This is to meet the business earnings requirement. Basically, Schedule C income has been filed. Without the income, not eligible. An LLC needs to be profitable.

I don’t think it has to be current or there is a requirement to make a contribution.
spiritrider or one of the CPA’s would be a better source. This is an aggressive interpretation.

[spiritrider]

As pointed out by Tim , under 401(c) in order to meet the definition of a self-employed individual eligible to to adopt, maintain and contribute to a 401k. You must be engaged in a legitimate trade or business with self-employed earned income (net earnings from self-employment) = (business profit - 1/2 SE tax) in the current or any prior year. If you never had/have legitimate self-employed earned income, the plan is not qualified.

The IRS expects a 401k plan to be a semi-permanent employer retirement plan. While there is no requirement to make employee and/or employer contributions in any given year. Is it a qualified retirement plan if you never intend to make employee and/or employer contributions and only do IRA rollover(s).

If a 401k plan was never qualified or disqualified because the only intention was tax evasion. The result can be catastrophic. Forced distribution of all assets, subject to ordinary income taxes, the 10% early withdrawal penalty and not eligible for rollover.

You should only adopt a 401k if eligible and intend to make employee and/or employer contributions. Only then should you consider doing an IRA rollover.

We are professionals and the probability of getting caught should never factor into the equation.

[blbaker28]

Getting caught is not my concern, actually breaking the law is. Hence the reason for my questions. I don't want to be in a position to worry about getting caught because I don't want to technically do anything wrong. Spiritrider, I think you hit on something that might clear up what I'm asking. When you say 'qualified' what exactly is meant by that. I can't find anything on IRS.gov or anywhere else where is says a contribution must be made every so often or else, or a kind of minimum size or anything like that.

Just to be clear, I have an LLC that does generate a small amount of revenue. I know you are allowed to be an employee elsewhere and have your own side-hustle and still qualify for a self-employed 401. Based on that, it does look like I'm eligible to open the self-employed 401. It also looks like I can role my TIRA into it since contributions and roll-overs are different. However, going back to the beginning of this thread and why I guess that customer service person asked if I plan on making contributions, it sounds like if I'm not making a contribution at least every so often, I could be setting myself up for trouble when the IRS sees that and asks "Why haven't you taken any revenue from your LLC and contributed it to your 401?" Does that sound right?

If I'm right then how much activity would I need to keep things above board? If I'm generating 1-2k a year in revenue and contributing say 100-200 a year, or maybe even every other year into the 401 would that be enough to keep everything legal and me out of trouble? What level of activity is needed in other words?

I realize that setting up a solo or self-employed 401 for the primary purposes of being able to take advantage of the back-door roth might seem dodgy to some and I can respect that. However, I am not concerned with the spirit or intention of these rules and regulations. If there is enough ambiguity in these rules and regs to allow me to legally use the system to keep as much of my money as possible, regardless if its outside the rule's intentions, well, then, yeah, I'm going to do that. I DO NOT want to do anything that breaks the rules or invites avoidable and unwanted attention from the IRS however. That's why I come here and ask these questions. I want everything to be above board, even if it is morally ambiguous.

again, I appreciate all the help and thoughtful feedback,

its very helpful!

b

[spiritrider]

As I pointed out, there is no requirement to make ongoing employee or employer contributions. However, since the whole purpose of a 401k plan is to make employee and/or employer contributions.

What is the legitimate purpose of adopting the 401k, if not to make those contributions. It is my opinion that you should at least make a contribution the first year. A better question is, why are you reluctant to make a nominal contribution do so and validate the purpose of the 401k plan?

[blbaker28]

I'm not, I'm learning as this thread is evolving. I have no problem making a contribution, in fact, I can see a lot of benefits to doing it. I just wasn't sure if a small amount of money every so often into the 401 was enough? I talked to someone else today who owns and runs their own LLC only its a much, MUCH, bigger concern. He told me pretty much any level of activity would be sufficient provided there is some. Similar to the LLC itself, it needs to be profitable every so often and it needs to show some revenue. These are really fairly low bars if you think about it. I just wanted to be sure to make sure I wasn't stepping into anything that could get me into trouble.

To provide more insight and to answer your other question about why else even open the 401, there are other reasons. My education about the pro-rata rule and its relationship to the back door Roth all mentioned moving your TIRA into either an employer 401 (403) or your own self-employed 401 if you can with the self-employed option being the preferred one. Meaning, if you are self-employed or simply have a side gig or hustle, those do count, they can help you take advantage of the back door roth if those options were available to you.

What no one discussed was whether or not that side hustle had a size requirement and if contributions must be made and if so, was there a frequency and size requirement to those as well. I'm learning all that here, mostly in this thread (thanks again to all the responses btw). I guess what I'm learning is that if I do this, and I want to stay out of trouble and continue to be able to use the self-employed 401, I better ************************ well be sure to make sure I can show some money going into this account. It doesn't have to be much, but it better be something to show you are legitimizing the 401.

Does all this sound about right?

[Tim]

If you had $1k profit per year in a legitimate side hustle that you ran through Schedule C each year, absolutely make a company contribution. Yes it is small. Just do it consistently and presto you have a business. The actions are more important than the size. Rollovers are unlimited. Keep in mind the $250k form 5500 reporting requirements.
A solo 401k is a 401k, not just an IRA.
You will end up paying the employer or taxes, not refundable.

[White.Beard.Doc]

How much income are you talking about here? Does your LLC earn in the hundreds of dollars per year? Thousands? Tens of thousands?

If the annual LLC earnings are de minimus, then I would think it could be considered a tax dodge if you use this rollover to enable backdoor Roth contributions.

[mamaham]

apart from your side LLC, are you employed? If you already have a 401k or 403b that accepts a rollover, can't you just roll over the TIRA there? No need to make a solo 401k?

WCI - Backdoor Roth FAQs blog post:
"Roll the money over into a 401(k), 403(b), or Individual 401(k). 401(k)s don’t count in the aforementioned pro-rata calculation. Some physicians even open an Individual 401(k) at Fidelity, eTrade, or Vanguard (rollovers from traditional IRAs to solo 401(k)s is a recent addition to Vanguard) in order to facilitate a Backdoor Roth IRA."

[spiritrider]

While there is no defined arbitrary minimum level of self-employed earned income to be eligible to adopt a 401k. 401(c) requires that it be from an individual engaging in a trade of business.

The IRS reiterated in their final Section 199A (QBI) Regulations; SCOTUS Higgins v. Commissioner ruling is the seminal Substantial Authority on what constitutes being engaged in a trade or business.

The ruling points out that there is no statutory or regulatory definition of being engaged in a trade or business. Instead it is based on a determination of facts and circumstances. The ruling requires the taxpayer to enter into and carry on the activity with a good faith intention to make a profit or with the belief that a profit can be made from the activity and engages in considerable, regular, and continuous activity.

My opinion is that your fact pattern of being engaged in a trade or business with adequate self-employed earned income meets the requirements to adopt, maintain and contribute to a 401k.

There is no specified size or frequency of contributions required.

[uksho]

While there is no defined arbitrary minimum level of self-employed earned income to be eligible to adopt a 401k. 401(c) requires that it be from an individual engaging in a trade of business.

The IRS reiterated in their final Section 199A (QBI) Regulations; SCOTUS Higgins v. Commissioner ruling is the seminal Substantial Authority on what constitutes being engaged in a trade or business.

The ruling points out that there is no statutory or regulatory definition of being engaged in a trade or business. Instead it is based on a determination of facts and circumstances. The ruling requires the taxpayer to enter into and carry on the activity with a good faith intention to make a profit or with the belief that a profit can be made from the activity and engages in considerable, regular, and continuous activity.

My opinion is that your fact pattern of being engaged in a trade or business with adequate self-employed earned income meets the requirements to adopt, maintain and contribute to a 401k.

There is no specified size or frequency of contributions required.

Once you make contribution to solo 401k when you are independent contractor and subsequent take up a job , do you have to roll over the money or you can keep in that account for ever without making any more contributions?

thank you

[spiritrider]

Once you make contribution to solo 401k when you are independent contractor and subsequent take up a job , do you have to roll over the money or you can keep in that account for ever without making any more contributions?

A one-participant 401k plan is like any other 401k plan. IRS regulations prohibit the in-service rollover of employee deferrals prior to age 59 1/2 and employer contributions are subject to plan restrictions prior to age 59 1/2. The only way unrestricted rollovers prior to age 59 1/2 would be allowed and required would be on termination of the plan.

While the IRS requires termination of a 401k plan, distribution and/or rollover when the plan sponsor "ceases to exist". Business inactivity in and of itself does not cause a sole proprietorship to cease to exist. I have had several year periods of inactivity.

The IRS has held that a sole proprietorship continues until death as long as it remains available for activity and takes no proactive steps to close. Partnerships and S-Corps can be subject to activity requirements.

Forever, is too strong a word. Any evidence in the very unlikely event of a plan audit, that the business remains available for activity, the longer it can remain inactive. Business cards and marketing materials is a good idea. A monthly blog or website would be better. Some revenue at least once every several years would be best for long periods of inactivity.

[jfoxcpacfp]

Just to be clear, being an owner of an LLC "that does generate a small amount of revenue" is not the first question we should answer. It is whether that LLC produces earned income. > half of the LLCs owned by clients are for the purpose of holding real estate for liability protection. Since you are still learning and I didn't see that specified above (after a super quick scan), let's be clear about this requirement. It's not the entity type that matters (in fact, curious why you have organized as an LLC), but is the classification of the income: earned, passive, investment, or something else.