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  • The Business vs. Hobby solo 401k omnibus thread

    Not sure if this will work but there is a discussion going on on 2 threads here (old) and here (new).

    The basic debate is whether it is ok for a doc looking to open a solo 401k to do something like a few online surveys and generate menial but real IC/1099 income.

    In one corner we have WCI saying that it's fine to open a solo 401k based on any income, in his words: "If you get paid $5 to do a survey, is that reportable income to the IRS? Absolutely it is. And where do you report it? You report it on Schedule C. What is Schedule C for? It’s for a business. What do you need to open an individual 401(k)? A business.. "

    In the other corner we have spiritrider and Johanna who describe this advice as "reckless," "a sham," and perhaps even more damningly "a hobby."

     

    So basically, who is right?

    FWIW my uninformed opinion is that WCI is right. That is in no way self-serving as it doesn't apply to me.

  • #2
    i have not had to do either, but i feel that if you earned 1099 income in any capacity you can open a solo 401k.

     

    similar thought, does a wash sale apply to 401ks.......i dont think so.

    Comment


    • #3
      I’m not advocating breaking any IRS tax laws, but I wonder what the real likelihood of an audit is for this sort of thing. I’d be curious to know how often Johanna or other CPAs have their clients audited. Knock on wood, but I’ve never been audited, although I’m not aware of any red flags that would possibly trigger an audit. Similar to the whole Roth for kids discussion, although that seems like it would be pretty low hanging fruit for the IRS.

      Comment


      • #4




        I’m not advocating breaking any IRS tax laws, but I wonder what the real likelihood of an audit is for this sort of thing. I’d be curious to know how often Johanna or other CPAs have their clients audited. Knock on wood, but I’ve never been audited, although I’m not aware of any red flags that would possibly trigger an audit. Similar to the whole Roth for kids discussion, although that seems like it would be pretty low hanging fruit for the IRS.
        Click to expand...


        I think the i401k thing is legit. If a SEP-IRA is okay for 1099 income, why not an i401k?

        The Roth for kids thing is questionable, to me, unless there is legitimate income. Someone here was asking over the weekend if he could open Roths for his kids under 5, for their modeling for his family photos? WTH?

        Comment


        • #5
          Example from new thread. Probably wasn't even a profit to begin with, because the item had a cost. However, all other minimal activities (a few surveys, a few hours on Uber) still fail.




          1. Sell an item on eBay for $1 (skip if you already have 1099 income from moonlighting) profit.
          Click to expand...


          From Section 401(c) though Sections 1402 and 162. A self-employed individual has earned income from a A trade or business carried on for a livelihood or in good faith to make a profit. There is no precise definition, but there is a pretty good reference to what is not. Simply filing a Schedule C is an income tax act, but it is not necessarily a qualification of a self-employed individual under 401(c)

          IRS Regulation 26 CFR 1.183-2 - Activity not engaged in for profit defined, (b) Relevant factors.

          1. The manner in which the taxpayer carries on the activity: If the activity is carried on "in a business like manner and maintains complete and accurate books and records" it is indicative of the activity being for profit.

            1. Maybe, How hard is it to keep accurate records for a few eBay sales, surveys, Uber records and car costs.



          2. The expertise of the taxpayer or his advisors: "Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are experts therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices."

            1. Fail. No indication this was undertaken with any planning.



          3. The time and effort expended by the taxpayer in carrying on the activity: If a taxpayer devotes a significant amount of time to the activity, it indicates the activity is for profit. The fact that a taxpayer does not devote a significant amount of time to the activity does not adversely affect the for profit determination so long as the taxpayer "employs competent and qualified persons to carry on such activity."

            1. Fail. Minimal effort for all activities



          4. Expectation that assets used in activity may appreciate in value: If the taxpayer expects to profit from the activity, this indicates it is for profit.

            1. Fail. What assets that appreciate on eBay, surveys, your car depreciates from Uber.



          5. The success of the taxpayer in carrying on other similar or dissimilar activities: "The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable."

            1. Fail. What other similar activities for eBay, surveys, Uber.



          6. The taxpayer's history of income or losses with respect to the activity: "Where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status, such losses, if not explainable, as due to customary business risks or reverses, may be indicative" that the activity is not for profit. "A series of years in which net income was realized would of course be strong evidence that the activity is engaged in for profit."

            1. Fail. A few bucks on eBay,  surveys, Uber rides.



          7. The amount of occasional profits, if any, which are earned: "Substantial profit, though only occasional, would generally be indicative that an activity is engaged in for profit, where the investment or losses are comparatively small." Also, "an opportunity to earn a substantial profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit."

            1. Fail. One time and miniscule if this was actually a profit.



          8. The financial status of the taxpayer: "The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit."

            1. Fail $1, $5, $10 are not even pocket change for a physician.



          9. Elements of personal pleasure or recreation: "The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit... It is not, however, necessary that an activity be engaged in with the exclusive intention of deriving a profit."

            1. You might get this one. Unless you derive pleasure or recreation from eBay sales, surveys and Uber.



          Comment


          • #6




            similar thought, does a wash sale apply to 401ks…….i dont think so.
            Click to expand...


            It clearly applies to IRAs, so I would assume it applies to 401(k)s, but honestly, nobody is looking at either one. If you're not buying and selling in the same account the brokerage isn't reporting it to the IRS. If you're not reporting it to the IRS because you're doing it in two separate taxable accounts that don't know about each other, then I don't see how the IRS is ever going to find out. It's the honor system there. But it's not a huge deal so I suspect it is a very low IRS priority.
            Helping those who wear the white coat get a fair shake on Wall Street since 2011

            Comment


            • #7




              Example from new thread. Probably wasn’t even a profit to begin with, because the item had a cost. However, all other minimal activities (a few surveys, a few hours on Uber) still fail.




              1. Sell an item on eBay for $1 (skip if you already have 1099 income from moonlighting) profit.
              Click to expand…


              From Section 401(c) though Sections 1402 and 162. A self-employed individual has earned income from a A trade or business carried on for a livelihood or in good faith to make a profit. There is no precise definition, but there is a pretty good reference to what is not. Simply filing a Schedule C is an income tax act, but it is not necessarily a qualification of a self-employed individual under 401(c)

              IRS Regulation 26 CFR 1.183-2 – Activity not engaged in for profit defined, (b) Relevant factors.

              1. The manner in which the taxpayer carries on the activity: If the activity is carried on “in a business like manner and maintains complete and accurate books and records” it is indicative of the activity being for profit.

                1. Maybe, How hard is it to keep accurate records for a few eBay sales, surveys, Uber records and car costs.



              2. The expertise of the taxpayer or his advisors: “Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are experts therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices.”

                1. Fail. No indication this was undertaken with any planning.



              3. The time and effort expended by the taxpayer in carrying on the activity: If a taxpayer devotes a significant amount of time to the activity, it indicates the activity is for profit. The fact that a taxpayer does not devote a significant amount of time to the activity does not adversely affect the for profit determination so long as the taxpayer “employs competent and qualified persons to carry on such activity.”

                1. Fail. Minimal effort for all activities



              4. Expectation that assets used in activity may appreciate in value: If the taxpayer expects to profit from the activity, this indicates it is for profit.

                1. Fail. What assets that appreciate on eBay, surveys, your car depreciates from Uber.



              5. The success of the taxpayer in carrying on other similar or dissimilar activities: “The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable.”

                1. Fail. What other similar activities for eBay, surveys, Uber.



              6. The taxpayer’s history of income or losses with respect to the activity: “Where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status, such losses, if not explainable, as due to customary business risks or reverses, may be indicative” that the activity is not for profit. “A series of years in which net income was realized would of course be strong evidence that the activity is engaged in for profit.”

                1. Fail. A few bucks on eBay,  surveys, Uber rides.



              7. The amount of occasional profits, if any, which are earned: “Substantial profit, though only occasional, would generally be indicative that an activity is engaged in for profit, where the investment or losses are comparatively small.” Also, “an opportunity to earn a substantial profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit.”

                1. Fail. One time and miniscule if this was actually a profit.



              8. The financial status of the taxpayer: “The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit.”

                1. Fail $1, $5, $10 are not even pocket change for a physician.



              9. Elements of personal pleasure or recreation: “The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit… It is not, however, necessary that an activity be engaged in with the exclusive intention of deriving a profit.”

                1. You might get this one. Unless you derive pleasure or recreation from eBay sales, surveys and Uber.




              Click to expand...


              So obviously I am not claiming to be even in your solar system with respect to this stuff but isn't this the Hobby test?

              My understanding of that test (if that's even the appropriate term) was more to make sure that taxpayers weren't doing stuff like buying a bunch of skiing equipment, doing one "lesson" with their friend's kids once a year, and trying to deduct their gear as a biz expense.

              Why does it apply here? Especially since in this case there is zero attempt to hide anything or avoid paying taxes? The money is still in a 401k what does the IRS care who administers it? Even in cases of minimal income like surveys/Uber there is really no serious suggestion that the taxpayer is engaged in a hobby (see your point about pleasure and recreation).

              Comment


              • #8




                I think the i401k thing is legit. If a SEP-IRA is okay for 1099 income, why not an i401k?


                You don't get a 1099-MISC until you have >= $600 in income. I and I don't think anyone else has a problem with that level of income.

                The problem is this idea that a few dollars from some limited time effort meets the IRS' vague definition; "A Trade or Business is generally an activity carried on for a livelihood or in good faith to make a profit. The facts and circumstances of each case determine whether or not an activity is a trade or business. The regularity of activities and transactions and the production of income are important elements."

                There is no precise definition, but I will paraphrase Justice Potter Stewart; "I don't know what is an adequate amount, but $1, 5, and $10 is an obscenity"

                Comment


                • #9
                  Remember of course what is going on here. We're trying to find a place to rollover an IRA to get rid of the pro-rata rule for Backdoor Roth IRAs, not trying to make contributions/get some huge tax deduction. So if you have a 401(k) or 403(b) at your current job or a former job, just use that. No reason to mess with an i401(k). If you have a tiny IRA, just convert the whole thing and pay the taxes. If you don't want to do Backdoor Roth IRAs, it's not that big of a deal. Just invest in taxable. You may even still be able to do a spousal Backdoor Roth IRA. But if you really want to do your own Backdoor Roth IRA, then press onward.

                  Spiritrider found a different list of 9 criteria than I did on the IRS site, but having started a couple of businesses and owned parts of quite a few, I can assure you the IRS isn't looking very closely here. Not that that is a reason to do something you know to be wrong, but it is a reason to not lie awake at night worrying about it.

                  But here's the deal, whatever list of criteria you want to come up with, someone can check the minimal boxes and claim a business, and thus use a 401(k) to rollover an IRA, then close the business. So let's take our classic example of "doing surveys" and go through the 9 criteria. Bear in mind the IRS cares about this criteria NOT to keep you from opening a solo 401(k), but to keep you from claiming a business loss indefinitely for your hobbies.

                  https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses

                  Question

                  How do you distinguish between a business and a hobby?



                  Answer



                  In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. No one factor alone is decisive. You must generally consider these factors in determining whether an activity is a business engaged in making a profit:

                  • Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.

                  • Whether the time and effort you put into the activity indicate you intend to make it profitable.

                  • Whether you depend on income from the activity for your livelihood.

                  • Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).

                  • Whether you change your methods of operation in an attempt to improve profitability.

                  • Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.

                  • Whether you were successful in making a profit in similar activities in the past.

                  • Whether the activity makes a profit in some years and how much profit it makes.

                  • Whether you can expect to make a future profit from the appreciation of the assets used in the activity.


                  # 1 Business like manner.

                  Okay, pretty easy to do this one. Get an EIN. Keep books. File a Schedule C. Open a 401(k). Want me to open a bank account? Fine. I'll do that too. It's businesslike.

                  # 2 Time and effort to be profitable

                  I own a business I put very little time and activity into. There is no minimum time here. But if you give me a minimum, well, you can do surveys until you hit it. Intend to be profitable? That's pretty easy. Minimal expenses and easy profits doing surveys.

                  # 3 Depend on the income

                  This one is a bit bizarre. I mean, I don't depend on my physician job for my livelihood, but that doesn't make it a hobby.

                  # 4 Losses beyond your control

                  With this one you can see what the IRS really cares about. Easy to avoid- don't claim a loss.

                  # 5 Change in operations to become more profitable

                  Okay, quit doing the $2 surveys and do the $20 surveys.

                  # 6 Whether you have the knowledge to be profitable

                  Sure, you're a doc. Do doc surveys

                  # 7 Past profitability

                  You've gotta start some time. But hey, you really want to make a fuss on this one. Fine. Do surveys this year. Then do then again next year and call it a business.

                  # 8 Whether the business is profitable in some years

                  Again, you see the IRS focus here- no claiming losses for hobbies. They don't care about your darn 401(k).

                  # 9 Profit from assets used in activity

                  I can't claim this one from my physician business either either. I'm sure there are lots of businesses that would struggle here.


                  Bottom line: 1, 4, 5, 6, and 8 are super easy to nail/convince an auditor of. 2, and 7 wouldn't take much more effort.

                  At any rate, you can start the business, make a profit, open a 401(k), do your rollover, and then decide you don't want to be in business any more because you were worried you couldn't meet these 9 criteria.


                  Now, look at the criteria that aren't on my list that are on spiritrider's. They're all focused on making a profit. If you're actually making a profit, the IRS doesn't care. They only care if you're claiming losses. So don't claim losses. Get your i401(k). Do your rollover and move on.
                  Helping those who wear the white coat get a fair shake on Wall Street since 2011

                  Comment


                  • #10




                    So obviously I am not claiming to be even in your solar system with respect to this stuff but isn’t this the Hobby test?

                    My understanding of that test (if that’s even the appropriate term) was more to make sure that taxpayers weren’t doing stuff like buying a bunch of skiing equipment, doing one “lesson” with their friend’s kids once a year, and trying to deduct their gear as a biz expense.

                    Why does it apply here? Especially since in this case there is zero attempt to hide anything or avoid paying taxes? The money is still in a 401k what does the IRS care who administers it? Even in cases of minimal income like surveys/Uber there is really no serious suggestion that the taxpayer is engaged in a hobby (see your point about pleasure and recreation).
                    Click to expand...


                    Like many things the hobby test incorporates 26 CFR 1.183-2, but this regulation exists independently of that test. It is used anywhere to define when an activity is not engaged in for profit.

                    The tax code is about way more that avoiding or comply with taxation. In fact, many IRS enforcement actions and penalties have nothing to do with taxation, but with compliance rules.

                    Sorry to disagree, but minimal income from transient activities such as a few surveys is the very definition of other income. Don't get hung up on the term "hobby income".

                    Look, I'm not saying that the IRS is likely to come knocking at anyone's door. Just that the forum members are more than capable of generating a reasonable amount of self-employment income for this purpose. It is just being lazy to not make an adequate effort to actually be self-employed without playing such games.

                     

                    Comment


                    • #11
                      Wait is this whole argument about whether the $600 barrier needs to be reached? So if I reach that doing surveys then both WCI and Spiritrider agree that’s enough to open a i401k?!? Not that I need to, but I’m pretty sure I’ve gotten emails on a few surveys paying a couple hundred bucks each. If that’s all that’s needed seems silly to risk this type of thing by not earning $600.

                      Comment


                      • #12







                        So obviously I am not claiming to be even in your solar system with respect to this stuff but isn’t this the Hobby test?

                        My understanding of that test (if that’s even the appropriate term) was more to make sure that taxpayers weren’t doing stuff like buying a bunch of skiing equipment, doing one “lesson” with their friend’s kids once a year, and trying to deduct their gear as a biz expense.

                        Why does it apply here? Especially since in this case there is zero attempt to hide anything or avoid paying taxes? The money is still in a 401k what does the IRS care who administers it? Even in cases of minimal income like surveys/Uber there is really no serious suggestion that the taxpayer is engaged in a hobby (see your point about pleasure and recreation).
                        Click to expand…


                        Like many things the hobby test incorporates 26 CFR 1.183-2, but this regulation exists independently of that test. It is used anywhere to define when an activity is not engaged in for profit.

                        The tax code is about way more that avoiding or comply with taxation. In fact, many IRS enforcement actions and penalties have nothing to do with taxation, but with compliance rules.

                        Sorry to disagree, but minimal income from transient activities such as a few surveys is the very definition of other income. Don’t get hung up on the term “hobby income”.

                        Look, I’m not saying that the IRS is likely to come knocking at anyone’s door. Just that the forum members are more than capable of generating a reasonable amount of self-employment income for this purpose. It is just being lazy to not make an adequate effort to actually be self-employed without playing such games.

                         
                        Click to expand...


                        Sure and I get that, I'm also teeing off Jim's long post.

                        At the very worst this seems like a victimless... I don't even want to say crime I would say maybe "favorable interpretation of the rules."

                        I have spent dozens of hours and some seriously genuine mental pain to make sure I am on the right side of IRS gray areas, but those seem to become thorny mostly when I am going to incur some benefit as it relates to taxes. That is not really on the table here. I want to be a good citizen but engaging in victimless interpretation of rules where that interpretation confers me no demonstrable benefit other than convenience of not having to deal with a prior employer seems pretty benign.

                        I think I understand the point your are making which sounds very legalistic -- which is not to say that it's incorrect. Admittedly I think my intuition is not always a great judge of what the IRS would say.

                        Do you have a sense of how this would play out in an audit? I mean why would an auditor notice or care that you had a solo 401k as long as you weren't breaking contribution rules?

                        Comment


                        • #13




                          Bear in mind the IRS cares about this criteria NOT to keep you from opening a solo 401(k), but to keep you from claiming a business loss indefinitely for your hobbies.
                          Click to expand...


                          That to me is the open and shut case here.

                          The rule seems to be in place (reasonably) to prevent business loss claims from sham businesses carried out with no inclination to grow, market, or even profit but rather to deduct material goods.

                          Comment


                          • #14
                            If you’re like me and rather enjoy this stuff you may find this tax court case interesting, and applicable to the conversation. Not to say this is some definitive case or anything. There are myriad hobby v business cases out there. I’ll hold my commentary because I don’t want to taint any opinions. Rather curious if folks come to similar conclusions that I did:

                            https://www.ustaxcourt.gov/USTCInOP/OpinionViewer.aspx?ID=11633

                            Quoting a few facts from the filing to pique interest:

                            Background
                            I. Petitioner’s Music Activity
                            Petitioner is an engineer, and he finds his work stressful. To reduce stress,
                            petitioner decided to develop his talents as a musician... Petitioner testified that he is most creative and productive as a musician when he is happy and that he enhanced his artistic creativity and productivity by dining out with his children, engaging in recreational pursuits such as bowling, hiking and camping, and traveling to new destinations.

                            II. Petitioner’s Tax Returns

                            A. 2013
                            Petitioner prepared and filed Form 1040, U.S. Individual Income Tax Return, for 2013, and attached three Schedules C, Profit or Loss From Business, identifying the underlying activities as “Music Production/Record Company”, “Photographer”, and “Musician”. Petitioner reported no gross receipts from these activities and cumulative expenses of $48,017 for 2013....

                            B. 2014
                            Petitioner prepared and filed a Form 1040 for 2014 and attached six Schedules C, identifying the underlying activities as “Music Production/Record Company”, “Photographer”, “Musician”, “Business Administrative Support”, “Graphic Arts”, and “Writer”. Petitioner reported no gross receipts from these activities and cumulative expenses of $21,080 for 2014....

                            Comment


                            • #15




                              If you’re like me and rather enjoy this stuff you may find this tax court case interesting, and applicable to the conversation. Not to say this is some definitive case or anything. There are myriad hobby v business cases out there. I’ll hold my commentary because I don’t want to taint any opinions. Rather curious if folks come to similar conclusions that I did:

                              https://www.ustaxcourt.gov/USTCInOP/OpinionViewer.aspx?ID=11633

                              Quoting a few facts from the filing to pique interest:

                              Background
                              I. Petitioner’s Music Activity
                              Petitioner is an engineer, and he finds his work stressful. To reduce stress,
                              petitioner decided to develop his talents as a musician… Petitioner testified that he is most creative and productive as a musician when he is happy and that he enhanced his artistic creativity and productivity by dining out with his children, engaging in recreational pursuits such as bowling, hiking and camping, and traveling to new destinations.

                              II. Petitioner’s Tax Returns

                              A. 2013
                              Petitioner prepared and filed Form 1040, U.S. Individual Income Tax Return, for 2013, and attached three Schedules C, Profit or Loss From Business, identifying the underlying activities as “Music Production/Record Company”, “Photographer”, and “Musician”. Petitioner reported no gross receipts from these activities and cumulative expenses of $48,017 for 2013….

                              B. 2014
                              Petitioner prepared and filed a Form 1040 for 2014 and attached six Schedules C, identifying the underlying activities as “Music Production/Record Company”, “Photographer”, “Musician”, “Business Administrative Support”, “Graphic Arts”, and “Writer”. Petitioner reported no gross receipts from these activities and cumulative expenses of $21,080 for 2014….
                              Click to expand...


                              This game completely changes when you try to claim losses or biz expenses. We are not talking about that. If you do a few surveys and try to deduct your car then clearly that is not allowed.

                              Comment

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