Solo 401(k) Questions - S-Corp / Eligibility (paging Spirit Rider...)

[glorga]

I am getting hopelessly confused by the complexity of this situation I have inherited, and would be grateful for any guidance (especially from SpiritRider, if you happen to see this). Before anyone suggests speaking to a CPA or lawyer; I have spoken to several, and have only gotten incorrect or conflicting advice to date, so thought I might get some clarity here. Also open to referrals to good CPAs if anyone has any.

My father opened a retail business as an LLC, and an enrolled agent bookkeeper advised him to elect to tax it an s-corp, although I am not sure that was good advice. My father has since sadly passed away, and the business is currently owned by his living trust, although the ownership will soon be pushed out upon the winding up of his living trust to myself and to a trust for another beneficiary (which I understand will need to be an eSBT or QSST to avoid disqualifying the s-corp election). The only remaining employee of the business is my spouse. I would ideally like to setup a solo 401k with my spouse as the sole participant.

Some things I am confused about:

1. Can I setup a solo 401k with my spouse as the sole participant if my spouse is an employee but not a part-owner of the business? If not, can I give her part of the business this year to cure that, and if so, does she have to meet an ownership threshold (e.g. 2% or 10%)?

2. Does the presence of other s-corp owners (e.g. the trusts) prevent eligibility for the solo 401k, or is it not an issue since there are no non-eligible employees and the spouse will be the only solo 401k participant?

3. In order for my spouse to be an eligible employee participant in the solo 401k, do I need to own part of the s-corp directly (i.e. do I need to wait until part of the ownership is pushed out from the living trust to myself directly)?

4. Is it better to unelect s-corp status and be treated as a multi-member LLC, i.e. taxed as a partnership, for any reason?

5. Ideally spouse would do a MBDR via a solo 401k from Employee Fiduciary, but given all of the above complications, I am wondering if it's better to just use a standard solo 401k provider like Fidelity and limit contributions to the employee deferral... The last thing I want is an issue with the IRS, given how difficult they are (e.g. they do not answer calls). Is a plan from Employee Fiduciary more likely to lead to mistakes than one from Fidelity?

6. If my involvement in the business is almost nil and limited to admin matters like setting up a solo 401k, checking that the CPA has made tax filings, etc., do I still need to pay myself "reasonable compensation"? My spouse does all of the actual work for the business. If I do need to, I assume I can then also participate in the solo 401k.

Many many thanks in advance for any and all guidance or thoughts.

[jfoxcpacfp]

So sorry on the loss of your father. I can answer some of the questions but also need more info and not sure I can give correct info on others.

• Does the business have other employees?
• How much taxable income per year?
• Yes, your spouse would need to be employed (s-corp) or owner (LLC/partnership) to participate in 401k.
• Is your mom still living and are you hoping to use the business as a conduit for her support?

Agree with you that SR might be the better choice here, but this will bump up your post and provide a little more info to help with the recommendation on dissolving the corporation or not.

Welcome to the forum, sad that your first post was about the loss of your father.

[glorga]

So sorry on the loss of your father. I can answer some of the questions but also need more info and not sure I can give correct info on others.

• Does the business have other employees?
• How much taxable income per year?
• Yes, your spouse would need to be employed (s-corp) or owner (LLC/partnership) to participate in 401k.
• Is your mom still living and are you hoping to use the business as a conduit for her support?

Agree with you that SR might be the better choice here, but this will bump up your post and provide a little more info to help with the recommendation on dissolving the corporation or not.

Welcome to the forum, sad that your first post was about the loss of your father.

Thank you very much for the kind words, and for any assistance. Even a small bit of insight is very helpful, as it can lead me in the right direction for additional reasearch and make my conversation with a CPA more productive, so it's very much appreciated. To answer your questions:

• Does the business have other employees? No. There were some last year, but following his passing, my spouse is now the only employee. She gets a W2. I have a day job and do not work on the business, other than for some admin matters like ensuring tax returns are timely filed, etc. I am unclear if this requires me to take "reasonable comp"; if so, I would of course comply and take some W2 income and be the only other employee.
• How much taxable income per year? Given his recent passing, and resulting change(s) in the business, it's very much not yet clear what the steady state will be going forward, but let's call it $75-100k of income, w/ $55-70k of W2 wages for the spouse.
• Yes, your spouse would need to be employed (s-corp) or owner (LLC/partnership) to participate in 401k. She is employed, but it's unclear to me whether or not she needs to be a partial owner as well.
• Is your mom still living and are you hoping to use the business as a conduit for her support? Not relevant / no.

Thank you again.

[jfoxcpacfp]

Thank you very much for the kind words, and for any assistance. Even a small bit of insight is very helpful, as it can lead me in the right direction for additional reasearch and make my conversation with a CPA more productive, so it's very much appreciated. To answer your questions:

• Does the business have other employees? No. There were some last year, but following his passing, my spouse is now the only employee. She gets a W2. I have a day job and do not work on the business, other than for some admin matters like ensuring tax returns are timely filed, etc. I am unclear if this requires me to take "reasonable comp"; if so, I would of course comply and take some W2 income and be the only other employee.
• How much taxable income per year? Given his recent passing, and resulting change(s) in the business, it's very much not yet clear what the steady state will be going forward, but let's call it $75-100k of income, w/ $55-70k of W2 wages for the spouse.
• Yes, your spouse would need to be employed (s-corp) or owner (LLC/partnership) to participate in 401k. She is employed, but it's unclear to me whether or not she needs to be a partial owner as well.
• Is your mom still living and are you hoping to use the business as a conduit for her support? Not relevant / no.

Thank you again.

I can see no purpose for an s-corp. Whether your spouse can be an owner of the LLC depends on state law for your profession. Having her as an owner may be counterproductive if she has no other earned income.

[spiritrider]

If this was your father's sole means of income. The election of an S-Corp might have been reasonable. An S-Corp with $75K - $100K of business profit as the only source of earned income might very well save more in FICA taxes than one with $300K - $400K in business profit.

1. Yes, a spouse can be a participant in a one-participant 401K without any ownership interest but she can not receive any distributions without ownership.
2. No, only eligible W-2 employees can be participants. You can elect employee eligiblity restrictions to limit some W-2 employees from participation.
3. Only the owner and potentially their spouse can be participants of a one-participant 401k. I don't see how the trust could be considered her spouse
4. With an S-Corp, FICA taxes would only apply to W-2 wages and not any distributions. In a partnership, if you were not a material participant, the same would be true. Your distributions would not be compensation subject to SE taxes.
5. If the ownership structures are resolved. I don't think the 401k plan provider matters.
6. The same material participation requirements that apply to a partnership apply to an S-Corp. Generally, the lowest qualification is usually the 500 hour/year requirement. From your description you do not meet the threshold. No employee = no compensation = no one-participant 401k participation.

My recommendation is to use a partnership, likely an LLC if this business; has premises, products or is based on more than the personal services of the partners. Her partnership ownership percentage will determine her self-employed earned income. Her one-participant 401k contributions will be limited to her self-employed earned income minus any employer contributions.

If you make her a W-2 employee, she can not be partner. Also, you will then automatically become the only material participant. All distributions to you will be self-employed earned income.

The key part of this that I have relatively sparse knowledge. Is how the current business legal entity, the trust and your ultimate ownership will be reconciled.

[glorga]

If this was your father's sole means of income. The election of an S-Corp might have been reasonable. An S-Corp with $75K - $100K of business profit as the only source of earned income might very well save more in FICA taxes than one with $300K - $400K in business profit.

1. Yes, a spouse can be a participant in a one-participant 401K without any ownership interest but she can not receive any distributions without ownership.
2. No, only eligible W-2 employees can be participants. You can elect employee eligiblity restrictions to limit some W-2 employees from participation.
3. Only the owner and potentially their spouse can be participants of a one-participant 401k. I don't see how the trust could be considered her spouse
4. With an S-Corp, FICA taxes would only apply to W-2 wages and not any distributions. In a partnership, if you were not a material participant, the same would be true. Your distributions would not be compensation subject to SE taxes.
5. If the ownership structures are resolved. I don't think the 401k plan provider matters.
6. The same material participation requirements that apply to a partnership apply to an S-Corp. Generally, the lowest qualification is usually the 500 hour/year requirement. From your description you do not meet the threshold. No employee = no compensation = no one-participant 401k participation.

My recommendation is to use a partnership, likely an LLC if this business; has premises, products or is based on more than the personal services of the partners. Her partnership ownership percentage will determine her self-employed earned income. Her one-participant 401k contributions will be limited to her self-employed earned income minus any employer contributions.

If you make her a W-2 employee, she can not be partner. Also, you will then automatically become the only material participant. All distributions to you will be self-employed earned income.

The key part of this that I have relatively sparse knowledge. Is how the current business legal entity, the trust and your ultimate ownership will be reconciled.

Thank you very much for weighing in! To make sure I am understanding correctly, assuming I keep the business as an s-corp, is the following correct:

1. In order for my spouse to be eligible for the solo 401, I will need to wait until the business (an LLC taxed as an s-corp) is transferred out of my father's living trust (since my spouse is not a spouse of the trust) to its beneficiaries (myself and a trust for the benefit of a disabled relative).

2. At that point, my spouse will be eligible since she will be the sole W-2 employee of the business and only participant in the 401k, and a spouse of one of the two owners.

3. The fact that the trust for my disabled relative owns a portion of the business will not disqualify my spouse from a solo 401k (understanding nobody else, including the trust, will be eligible to participate).

4. You state that my spouse "can not receive any distributions without ownership". I assume you mean profits or similar distributions, which I understand; as those would flow to myself and the trust. She will just have her W-2 salary, but not otherwise share in the profits.

5. Since I don't participate at least 500 hours/year, I do not materially participate and thus do not need to take a "reasonable salary". That's good, however, the downside is that I cannot then myself participate in the solo 401k even if the business has earnings that are distributed as profits to me, so the solo 401k would be for my spouse only.

Assuming instead I unelect s-corp taxation and operate the existing LLC as a multi-member LLC taxed as a partnership:

6. I could leave my spouse as a W-2 employee, she could participate in the solo 401k as the spouse of an owner, but she cannot be a member/partner of the LLC.

7. Since I am the only other participant in the business (other than the completely passive trust for the disabled beneficiary), I would be deemed a material participant een though I spend far less than 500 hours, and any distributions to me would be subject to SE taxes. If I max out FICA at my day job though, I would not have to pay more FICA (but would pay medicare). Since I am deemed a material participant, I can in this case participate in the solo 401k myself as well, based on any distributions which would be SE income to me.

I am sure some of the above is incorrect....apologies if I am being slow here (it must be frustrating to be seemingly the only person on the internet who understands all of this well and constantly explain it to those who do not...). Many many thanks for your help.