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Self-Employed 401k Excess Contribution -- Help? :(

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  • Self-Employed 401k Excess Contribution -- Help? :(

    Hi there, hoping someone here might be able to point me in the right direction! It's wild to me how I almost always get better advice/info here than people who are actually paid to know this information (!)

    - I have a Self-Employed 401k through Fidelity where I made tax-deferred contributions to via my 1099 sole-proprietorship income.
    - I also have a employer-sponsored 401k, also through Fidelity, where I contributed a very small amount in year 2022 (far less than the limit).
    - I over-contributed to this Self-Employed 401k by $2,500 for year 2022 (I had contributed in October 2022 and ended up working less shifts in the coming months, reducing my total contribution cap).
    - This $2,500 over-contribution was an employER contribution (not employee) and was done during the actual year 2022.
    - The over-contribution was put into a mutual fund position that lost money during that period of time.
    - I have NOT yet filed my taxes for year 2022
    - I have reviewed prior WCI forum posts and Googled to see if this question has been answered before (seems like it could be a relatively common occurrence for our community?)

    - Can I remove an excess employER contribution without paying any penalty? Reviewing prior Spiritrider posts on WCI forums, this seems like the answer is "no."
    - Barring that, can I reclassify my employER contribution to an employEE contribution and would that somehow change things? I'm guessing the answer is also "no."
    - Barring the above, how do I go about paying fees and completing this process correctly? It looks like I have to fill out Form 5330? I'm not sure how I would do this with Turbotax (I have Home & Business downloaded edition). Do I have to fill out multiple 5330s for 2022 and 2023? I'm so lost on this process...

    Additional Info:
    - I called Fidelity last week and their agent told me it would be an easy fix, that I would have to sell the $2,500 position first (to convert it to cash reserves), and that I could then complete a form via Fidelity that would allow me to withdraw it. She said Fidelity would then issue a 1099-R for year 2023, and I would have to complete a Letter of Communication to the IRS to explain the situation. She told me it was too late to have any 1099-R filed for this tax year 2022.
    - Given that there were no gains (only losses) on the $2,500 excess contribution, she told me there would not be any penalties.
    - It's been several days now and Fidelity has not sent any form or link to complete the withdrawal.
    - I called Fidelity back today, and a different agent gave me a very different story -- he said that my only option was to roll the $2,500 over as a 2023 contribution, and pay a 10% fee as a result, and to complete IRS Form 5330 on this year's taxes.
    - When I mentioned my prior conversation with the first Fidelity agent a few days ago, he said that only applied to IRAs (despite being exceedingly clear that it was a Self Employed 401k during my initial conversation with the first rep). Of course he could not find any notes from that initial conversation...
    - I've tried searching both these forums and Google without a ton of success. I've found that most of the information given applies to employer sponsored 401ks, not Self Employed 401ks (where I am the owner as a sole-proprietor)
    - The most pertinent article that I have found from Google comes from (not sure how credible this source is), which states (bold my emphasis, for what seems pertinent to my situation):

    If at all possible, you want to withdraw the excess amount from your Solo 401k before the end of the tax year (Dec. 31). If that is not possible, your next choice is withdrawing it before tax day.

    If the excess contribution was made to an employer-sponsored plan (other than your Solo 401k), contact your employer or plan administrator. Tell your plan administrator you’ve made an “excess deferral.” The plan administrator will return the excess funds to you as a “corrective distribution.” They will also calculate and return the additional earnings (if any) and issue new paperwork that corrects the over-contribution. If the excess contribution happens in your Solo 401k, you’ll need to take these actions as the plan administrator.

    You will also need a new W-2 and have to pay the taxes on the additional income for the year. Your income will increase by the amount of the returned excess contribution plus the earnings. Essentially, your tax bill will rise (or your refund will be reduced) relative to the amount of the excess 401k contribution.

    If you do not complete these actions before tax day (April 15 most years or July 15 for 2020), you will face the double taxation penalty.

    Report corrective distributions on IRS Form 1099-R. Your Solo 401k needs to issue a copy for your personal records and send a copy to the IRS.
    - The most relevant WCI forum post I've found has Spiritrider suggesting that employER contributions are NOT removable, but that there might be an option to reclassify employER contributions as employEE contributions to get around this?
    - Given that I hit the cap on my solo-401k regardless, I suspect any reclassification would not be helpful.
    - So all that to say -- it looks like I'm going to owe 10% excise tax on $2500 ($250). Is there any advise on how to complete this most efficiently?

    Thank you in advance for any help, anyone!

  • #2
    Originally posted by Hopsadoodle View Post
    - Can I remove an excess employER contribution without paying any penalty? Reviewing prior Spiritrider posts on WCI forums, this seems like the answer is "no."
    - Barring that, can I reclassify my employER contribution to an employEE contribution and would that somehow change things? I'm guessing the answer is also "no."
    You are in luck with your facts and circumstances.

    While you can not remove excess employer contributions made during the tax year. If you have available employee deferral space you can reclassify the excess employer contributions as employee deferrals.

    The reason you see so many problems from excess employer contributions is because most moonlighting white coats have maxed their employee deferral limit at their primary job.

    For future reference, I recommend making quarterly employer contributions. They should be based on no more than 90% of you expected self-employed earned income. Make the contribution for the 4th quarter after the first of the year.

    Any excess contributions up to that amount can be allocated to that tax year by not deducting for the prior year. Then provided you have available contribution space for that year. There will be no excess employer contributions.


    • #3
      Hi Spiritrider! Thanks for dropping by -- I always appreciate your insight and advice (and have learned more than you know just by reading your comments in other threads where I've lurked)

      So I'm a bit confused --
      How does reclassifying the employER contribution ($2500) to employEE help me in this circumstance? I am under the impression that I'm over the TOTAL limit for my Self-Employed 401k, regardless of employER vs employEE designation, so it would still be over the limit regardless of it's classification.

      To clarify --
      - In 2022 I made two employER contributions to my Self-Employed 401k ($30k in March, $31k in October) to hit what I *thought* would be my max of 61k. [your advice to make these deposits quarterly based on 90% income is noted and great advice moving forward]
      - I have a separate employer-sponsored 401k where I made about 2k worth of contributions from my W2 job.
      - Come tax season, I realized I had not made enough 1099 money to fully max the Self-Employer 401k ($58.5k is my calculated max, for a $2500 over-contribution since I had put in $61k)
      - So now I have $61k (via those two employER contributions) in the Self-Employed 401k, and I'm seeing what the best way to remedy this is.
      - Wouldn't reclassifying $2500 of that employER contribution still have me over the max ($58.5k) since it's the total amount of contributions between the two? Or do I have that wrong / a fundamental misunderstanding of how to add up all the pieces to this sausage? I've been going primarily off a past thread you've been involved in
      - As I type this, I'm realizing that the fact I made these employER contributions via two large deposits might also change the calculus and render any of this moot... does it? Or can I reclassify a portion of one of those deposits?

      Thanks again for your help.


      • #4
        • Employee deferrals can be up to 100% of compensation
        • Employer contributions can be up to 25% of compensation*
        • Total (employee + employer) annual additions can be up to the lessor of 100% of compensation or the statutory limit.
        • The EGTRRA of 2001 effective 1/1/2002 removed the requirement that employee deferrals be included in the employer contribution limit.
        Reclassifying the excess as an employee deferral should resolve the problem. Please clarify what your 2022 compensation was.

        *25% of W-2 Box 1 or 20% of self-employed earned income (business profit - 1/2 SE tax).

        Note: There is no relevance of the size of contributions to the removal of any excess contributions.


        • #5
          Hi again!

          My total 2022 self-employed earned income (profit - 1/2 SE tax) was $297,488. So 20% of that ends up being $59,498 (max employER contribution, per your bullets)
          I contributed 61k total to the Self-employed 401k as mentioned, so essentially $2500 excess ($2502 if we're being exact).

          So my understanding, then, is that I could just reclassify $2502 of my employER contributions (which has been all of the 61k, so far) as employEE contributions, since that will bring my employER contributions just to the max ($59,498).

          Follow up questions then:
          - How does one "reclassify" that excess contribution, then? I've been sure to put "employER contributions" on my all my checks deposited to Fidelity and include a letter/communication stating as much. Can I simply write them a letter to request this? My understanding is that they don't even really keep track of type of contribution (employER vs employEE), and that I'm really just doing this in case of an IRS audit (or so an agent told me long ago). Or do I need to communicate this to the IRS somehow?
          - How do I clarify this in Turbotax, then? I'm not sure if you'd be able to answer this since you probably don't use the software and do your taxes yourself?

          Thank you!!


          • #6
            You should be filling out Fidelity's Self-Employed 401(k)—Contribution Remittance Form for each contribution. I don't know if Fidelity is tracking this, but you could call and ask them if they would reclassify this.

            Regardless, you will want to have a filled out form for your records. This needs to be tracked to meet contribution limits. Also the distributable nature of employee deferrals and employer contributions are different.

            You do not report one-participant 401k contribution types on your tax return. The only time when one-participant 401k contributions are fully reported is when you are subject to Form 5500-EZ filing requirements. When the one-participant 401k's end of year balance is > $250K.