i401(k) Contributions

[agwalker]

I'm working a new job in a practice as an independent contractor and I've opened an i401(k). Was hoping someone might be able to clarify a couple of topics.

Per Vanguard regarding i401(k)'s, "Employers can contribute up to 25% of compensation* not to exceed $61,000 for the 2022 tax year and $66,000 for the 2023 tax year. Employees can defer 100% of their compensation* up to $20,500 for the 2022 tax year ($27,000 for employees age 50 or older) and $22,500 for 2023 ($30,000 for employees age 50 or older).

Though I'm paid by the business, is it correct that I'd technically be a self-employed individual as opposed to an employer? In which case I would be able to fund my i401(k) with up to $20,500 for the 2022 tax year? Thanks for the help!

Best,

Alex

[JBME]

yes if you're getting a 1099 then you can fund an i401k. But you can only fund with 2022 contributions if you opened the i401k by December 31, 2022 and you can only make 2022 contributions based on your 2022 compensation

[spiritrider]

A self-employed individual is both employer and employee. They can make both employer and employee* contributions.

*Refer to my next post.

[spiritrider]

yes if you're getting a 1099 then you can fund an i401k. But you can only fund with 2022 contributions if you opened the i401k by December 31, 2022 and you can only make 2022 contributions based on your 2022 compensation

This is no longer entirely true.

While it used to be true that a 401k was required to be adopted by 12/31. The original SECURE Act, changed this effective with the 2020 tax year. A business has until their tax filing deadline including extensions to adopt a 401k.

• The allows them to make employer contributions until their tax filing deadline including extensions
• The requirement to complete an employee deferral election by 12/31 was not changed. A 401k must still be adopted and an employee deferral election completed by 12/31 to make an employee deferral for that tax year.

Bottom Line: A one-participant 401k plan can be adopted and a 2022 employer contribution made by the business until the tax filing deadline (4/18/23) including extensions (10/16/23). However, no 2022 employee deferral can be made unless it was adopted and an employee deferral election completed by 12/31/22

[JBME]

thanks, so the OP is SOL on the $20,500 of employee contributions for 2022 but can contribute 25% of total comp to the plan in the form of employer contributions

[spiritrider]

That is a reasonable assumption unless the OP clarifies they adopted the one-participant 401k and made an employee deferral election by 12/31/22.

[truphao]

I am going to throw a monkey wrench here. Under SECURE 2.0 section 317, a Sole-Prop can RETROACTIVELY elect to defer for a new startup 401k for PYs beginning after 12/29/22. If anyone is OK to be aggressive then the following should work giving a full deduction for 2022 for a sole-prop:

Establish initial plan year from 12.30.2022 till 12.31.2022. The elect to defer full $20,500/$27,000 and also do a full Profit-Sharing up to $40,500 (dependent on income). Obviously, I am skipping quite a bit of technical details here. Please note that not a single big box vendor (Fidelity, Schwab, Vanguard, etc.) and that would require services of TPA.

[spiritrider]

I wouldn't call it a monkey wrench. I would say the OP lucked out. I was not aware of this new provision in SECURE Act 2.0. Then again there are so many new provisions. Just when you think you understand things...

It is notable that this provision makes no mention of an employee deferral election. Does that mean none is required or the sole proprietor also has until their tax filing deadline (without extensions) to make the election.

Your idea may very well work. A sole proprietor's compensation is treated as having all been received on the last day of the year. They can make the adoption date in the Adoption Agreement 12/30/22.

The OP would have until the 2022 tax filing date (4/18/23) to adopt* a one-participant 401k and make employee deferrals** for 2022.

*While not explicitly stated in Section 317, I would make an employee deferral election before making the deferral.

**Since it would have been allowed before SECURE Act 2.0, the OP should have until the tax filing deadline including extensions (10/16/23) to make 2022 employer contributions. Personally, I would make them both at the same time

[truphao]

"Your idea may very well work. A sole proprietor's compensation is treated as having all been received on the last day of the year. They can make the adoption date in the Adoption Agreement 12/30/22."

Unfortunately this is not my idea - can't take a credit for that - just picked it up during my convo with another TPA. It definitely feels like it would work - but I personally find it to be on aggressive side.

[agwalker]

The i401k was set up in 2022, but I wasn't familiar with the employee deferral election to complete that. So to JBME's point, SOL on the $20,500 of employee contributions for 2022, but I can contribute 25% of total comp to the plan in the form of employer contributions.

So this would be 25% of my income from them up to 12/31/22?

[truphao]

Assuming your Self-employment income is above IRS maximum amount ($305,000 for 2022) you should be able to defer $20,500 (plus another $6,500 if you were over age 50 on 12.31.2022) and also do a Profit-sharing allocation of $40,500 (=$61,000 - 20,500). I strongly recommend having an election to defer $20,500 on file dated before 12.31.2022 (this is what I ask my clients to do although in a sole-proprietorship situation one can argue it is not necessary). The money has to be physically deposited before you file the tax return.

[spiritrider]

I strongly recommend having an election to defer $20,500 on file dated before 12.31.2022 (this is what I ask my clients to do although in a sole-proprietorship situation one can argue it is not necessary). The money has to be physically deposited before you file the tax return.

I'm not sure how one can argue that.

IRS Regulation 1.401(k)-1(a)(6)(iii) Timing of self-employed individual's cash or deferred election.

"Accordingly, a self-employed individual may not make a cash or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of that year."

Also, contributions do not have to be made before you file your tax return.

Just like regardless of when you actually file, you can make an IRA contribution until your tax filing deadline. A self-employed individual can make both employee and employer contributions until their tax filing deadline including extensions.

In fact, a self-employed individual can file for an extension, file by the tax filing deadline and still have until the extended due date to make contributions.

[truphao]

"Accordingly, a self-employed individual may not make a cash or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of that year."

I am in total agreement, I run my clients with making elections before December 31st. Send it to me before December 31. If you did not, please find it in your other drawer - it is got to be there since we have talked about it so many times.

However, I have heard some arguments that it is really a conundrum since the self-employed earnings are not really known until the time you actually file your return. I am also aware that some well known big financial institutions are not forcing/processing/tracking the pre-December 31st elections properly if at all. But if you look for long and hard enough, you are likely to find compliance issues (on plan document , administration or operation level) with ANY retirement plan in the country.

Let's consider an example. A self-employed doc sponsors 401(k) plan and makes an election to defer $26,000 before December 31st. This doc made 300K in 2022 and decides to establish a Cash Balance Plan retroactively to 1/1/2022. Due to her age (lets assume she is a mature person) I can design the plan to generate a deduction of $275,000 for 2022. Thus, her income just dropped to 25K (the numbers are rounded and skipping some actuarial/tax gymnastics here). What do I do here? Is her election a valid legal action? I do not know. This is just a stretched-out example of how complicated the rules are.

I have also heard a notion regarding a "flexible election". Let's have the election in place before December 31 but instead of the specific amount let's use flexible language regarding the "reasonable amount up to a maximum allowable by law". Is it really a valid legal election? I do not know, but this is a question for attorney.

I personally like keeping things simple and well-documented but it is not always possible.

[truphao]

Also, contributions do not have to be made before you file your tax return.[/I]

Just like regardless of when you actually file, you can make an IRA contribution until your tax filing deadline. A self-employed individual can make both employee and employer contributions until their tax filing deadline including extensions.

In fact, a self-employed individual can file for an extension, file by the tax filing deadline and still have until the extended due date to make contributions.[/QUOTE]

Agreed, I misspoke, had my head wrapped up into the tax filing extension vs Form 5500 extension, my apology.

[spiritrider]

However, I have heard some arguments that it is really a conundrum since the self-employed earnings are not really known until the time you actually file your return. I am also aware that some well known big financial institutions are not forcing/processing/tracking the pre-December 31st elections properly if at all.

The tax code and IRS regulations are very clear on this. Besides, you only need to know your exact self-employed earnings to make dollar contributions. You know approximately what your earnings will be by the end of the year.

This should be more than sufficient to make an employee deferral election. You still have full discretion on employer contributions or employee after-tax contributions (if supported).

Let's consider an example.
.
. Actual numbers are not relevant
.

What do I do here? Is her election a valid legal action? I do not know. This is just a stretched-out example of how complicated the rules are.

This is well defined. A protected benefit (employer contributions) always overrides employee contributions. The IRS even has a very detailed ordering if employee deferrals have employer matches.

I have also heard a notion regarding a "flexible election". Let's have the election in place before December 31 but instead of the specific amount let's use flexible language regarding the "reasonable amount up to a maximum allowable by law". Is it really a valid legal election? I do not know, but this is a question for attorney.

I personally like keeping things simple and well-documented but it is not always possible.

While large corporations* may restrict employee deferrals elections to compensation percentages or less common per pay period dollar amounts. The IRS has no such restriction.

However, your example does not meet requirements. An employee deferral election must be deterministic*, where only the self-employed earned income and contributions are left to be calculated.

*In other words, only the exact execution of the election can be done after 12/31. The individual has no flexibility in applying the election.