W2 and 1099 pre tax issue

[AZGoBlue]

Hi Everyone,

Been lurking on the site for the last 5 years or so, and knew there was no better place to get some advice.

Long story short is that after almost 4 years of being a pre-partner in a democratic EM group, they decided to sell (I was 5 weeks short of making partner) and cut out all 12 pre-partners.  Needless to say I bitterly gave my notice and joined another group in town.  During the transition period I formed an LLC and did some 1099 work.  The combined salary for my wife and I was much higher in 2017 than it will be in 2018 for various reasons and I was trying to figure out a way to put as much away pre-tax as I could for 2017.

I almost maxed out our pre-tax savings from my W2 (45k) and her W2 (18k + match) income.  My thought was to establish an individual 401k and contribute as an "employer" as much as I could from the 1099 income.  I called and spoke with Vanguard and was told to do a SEP-IRA instead because there were more options available and I wouldn't be able to contribute as an employee anyways since I had already maxed that out with my W2 income. The thought was to contribute to the SEP as the employer.

Since then it has dawned on me that by doing so I may have screwed up my backdoor roth contribution (which I did early January 2017 and have already done my 2018 contribution).  I called vanguard today to figure it out and to see if I could open a solo 401k to roll the SEP IRA money into to avoid any additional taxes.  They told me that I should have never opened up a SEP or even a solo 401k because I would not be able to contribute anything to it since I maxed out my W2 employee contribution.  I knew there was a max on 401k employee contributions by SSN but thought that an employer contribution was separate.

Now I am thoroughly confused and unsure of what the best thing to do would be.  I'd like to minimize my tax bill as much as possible while maximizing pretax savings both in 2017 and 2018.  In case numbers would help, my 1099 income was about 35k and our combined income for 2017 was 675k.  The only debt we have is our house as we finally paid off our 514k in student loans in December (!!).

Sorry for the long post.  Any thoughts or help would be greatly appreciated.

[Medikit]

If I'm understanding this correctly you are a 1099 employee and you contributed to a SEP IRA with 2017 and want to open a solo 401k going forward in 2018. Your overall goal is to increase maximize your pre-tax savings and your secondary goal is to contribute to a backdoor which is unfortunately on hold because you have a large amount of income in a SEP IRA.

I believe the person you spoke with at Vanguard is incorrect- you can still make a solo 401k contribution with an employer contribution, however, it is too late to do that for 2017. Open up a 401k somewhere that allows you to rollover IRAs (ie Fidelity) see https://www.whitecoatinvestor.com/where-to-open-your-solo-401k then rollover your SEP IRA and use the Solo 401k going forward in 2018. Now that you don't have W2 income you can make both employee and employer contributions and should be able to max it out.

[spiritrider]

You must adopt a one-participant 401k by 12/31 of the tax year you wish to make contributions for. Therefore, it is too late to open a one-participant 401k for 2017.

You have until your tax filing deadline (04/17/18) including extensions (10/15/18) to adopt and make SEP IRA contributions for the 2017 tax year.

If you made SEP IRA contributions on or before 12/31/17. That would have been a mistake. Form 8606 uses all pre-tax balances of all traditional, SEP and SIMPLE IRAs on 12/31 of the year you actually do the Roth conversion for pro rata purposes.

In this case your best bet would be to undo the Roth conversion by recharacterization. Then redo the conversion in 2018.

If you made the SEP IRA contribution in 2018 there is no problem with a 2017 Backdoor Roth including the conversion done 2018. Remember, it is your pre-tax balances in the year the conversion is done.

Regardless if you made the SEP IRA contribution in 2017 or 2018. You will still want to rollover the SEP IRA to the 401k prior 12/31/18. Either roll it over to you new employer's 401k if they accept rollovers. Or adopt a one-participant 401k in 2018 and rollover the SEP IRA to the one-participant 401k.

It is disappointing to see yet more examples of Vanguard CSRs giving incorrect information. There was time when that would never happen.

The fact that you maxed your employee deferrals only would restrict those in a one-participant 401k. The employer contribution there or to a SEP IRA would not be affected.

You have a separate annual addition limit; 2017 = $54K and 2018 = $55K for each unaffiliated employer.

[AZGoBlue]

Thanks for the quick replies.  Am I understanding right that I can recharacterize my 2017 Roth and then contribute the $5500 in 2018 but classify it as a 2017 contribution?  Or should I just back out the contribution made to the SEP for 2017 and claim it as taxable income?  I only put $1000 in and was planning on putting in the rest once I figured out my taxes and how much I would be able to contribute as the employer after deductions.

Ultimately I want to do what is most tax efficient (and obviously legal).  I've already come to terms with the fact that the bad advice from Vanguard will prevent me from contributing any of my 1099 income as pretax for 2017.  Just want to minimize the damage (ie taxes).  I also want to set myself up for this not happening again in 2018 assuming I continue to moonlight.

Again, really appreciate the help.