Backdoor Roth and solo 401k nightmare

[Adrian]

Hello friends,

I need your help (again).

I've been doing backdoor Roth for a few years. Then in 2015 I joined a private practice. The contract is pretty complex, and the practice is set up as a LLC with me being a limited partner that does not receive gains or loses. I am paid on a K1. My CPA told me is OK to open a SEP IRA or solo 401k with 20% of my net income from there. Said SEP IRA is easy and simpler so I opened one.  Also told me is OK to keep doing backdoor Roth conversions, which I did until last year. Both advices were wrong!

First I found out is NOT OK to do backdoor while I have a SEP IRA (from this forum, by the way, so thank you very much!!). So I rushed to roll it over to a solo 401k at the end of 2017. Even though the request to liquidate it went in on December 23rd, the check from SEP IRA went to solo 401k on January 2nd (in the same institution, mind you, Merrill Lynch).

Then I found out that because the way the practice is set up and I am a "limited partner" and not a sole proprietorship, I do not qualify to open a solo 401k unless the entire practice has one (which it does not).

So my same CPA now tells me to roll the money back into a Traditional Rollover IRA. I know I do not qualify to open a Traditional IRA due to high income, but he says a Rollover Traditional IRA had different rules than the IRA contribution rules.  And I take it I can kiss backdoor Roth goodbye now.

Obvioulsy I do not trust the guy for anything anymore, but he got me into this mess and I want him to see me out and get clean with Uncle Sam.

Hence my post

Thank you

 

[DMFA]

It's not uncommon for those to take 5 business days as it is...and Tue 1/2/18 was the 5th business day after Sat 12/23/17 (Mon 12/25 was Xmas).

SEP-IRA would have been easier to remedy; could just have withdrawn excess contributions.  Now that you've become ensnared in the red tape of an ERISA plan, there are tighter regulations and penalties for screwing it up which can invalidate the plan (though it seems to be invalid as it is).  Now you've got an account which is working on its 3rd form in which there should be literally zero in the first place.  I don't think calling it by any other name is sufficient; I think you've got to withdraw it by 4/18 and pay income taxes on it for 2017.  Either way it's an excess IRA contribution, an excess SEP contribution, or an excess 401(k) contribution.  Leaving it in a SEP or Traditional IRA would incur 6% penalty each year until withdrawn, and in a 401(k) it would incur 10% penalty if withdrawn after 4/18.

I do not know the specifics of these because with my limited experience I only know how to avoid penalties, not deal with them. :-(  spiritrider or Kon Litovsky would know.

What retirement account does your partnership have?  It must have something, right?  Maybe SEP or SIMPLE IRA?  Can you at least put some of it into that and withdraw the rest of the excess contribution?  Can you start another self-employed business in 2018 (even a few hundred dollars with surveys or something) so you can at least dump out your pretax IRAs into an SE 401(k)?

[Adrian]

No, the practice does not have ANY retirement plans, is a small practice.

I read about opening a solo401k with money from online surveys and then rolling over thousands of dollars. I probably did one or 2 surveys in the last year, that is maybe $20. But there is no statment or anything...

I thought too that the simplest and legit thing to do would be to withdraw it and pay income and penalty taxes for all years it was opened (I contributed about 30k for 2015 then 25k for 2016, I did not make any contributions for 2017). What about the Roth IRA made from backdoor contributions while the SEP was opened?  Should I withdraw those contribution too?

[DMFA]

Adrian wrote:

No, the practice does not have ANY retirement plans, is a small practice.

I read about opening a solo401k with money from online surveys and then rolling over thousands of dollars. I probably did one or 2 surveys in the last year, that is maybe $20. But there is no statment or anything…

I thought too that the simplest and legit thing to do would be to withdraw it and pay income and penalty taxes for all years it was opened (I contributed about 30k for 2015 then 25k for 2016, I did not make any contributions for 2017). What about the Roth IRA made from backdoor contributions while the SEP was opened?  Should I withdraw those contribution too?

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No, those were your $5,500 allowed annual Traditional IRA contributions that were not deducted.  Assuming you declared those properly to the IRS using form 8606 for those years, those should be fine.

Jeez.  You'll owe extra taxes/penalties on the 2015 and 2016 ones and may need to file amended 2015 and 2016 taxes.  And because the contributions that you'd be attempting to rollover into a 401(k) were invalidated, then the max you'd be able to put into that 401(k), based on $20 net profit, would be a whopping $4.  The "no limit on rollovers" assumes that the money was already in an account it was actually allowed to be in.

I like to think I know things, but this is above some-guy-on-the-internet level of advice needed.  You need a good, trustworthy professional for this, preferably a CPA.  Consider looking here: https://www.whitecoatinvestor.com/financial-advisors/

Yikes.  Sorry.

[DMFA]

Adrian wrote:

No, the practice does not have ANY retirement plans, is a small practice.

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Not even SIMPLE-IRA?  I think you need to talk to your partners.  Surely you guys need to do *something* for tax-advantaged accounts.

https://www.irs.gov/retirement-plans/plan-sponsor/small-business-retirement-plan-resources

Or talk to a firm like Litovsky's.  The fees should pay for themselves in business taxes saved.

[spiritrider]

DMFA is correct, this is a serious problem. You were never eligible to open any employer retirement plan based on partnership K-1 distributions. For the purpose of employer retirement plans, the partnership is the employer and the only one eligible to adopt an employer retirement plan. Partners are considered employees and are not eligible to adopt such plans.

The bottom line is that you were not eligible to adopt the SEP IRA. The 2015/2016 SEP IRA contributions were excess contributions. Also, you were not eligible to adopt the 401k and the SEP IRA assets were ineligible for rollover. So you now have ineligible assets in a 401k.

It is going to take someone with very specific knowledge of correcting SEP IRA and 401k plan errors. Like DMFA, I am reasonably knowledgeable about employer retirement plans for owner-employees. I know generally how these plans errors are corrected. However, with this fact pattern, I could not in good conscience advise you on the specifics of correcting these errors. There are already going to be excise taxes and amended returns required, but there are the possibility of other penalties and fees if this is not done in a correct and timely manner.

It is unlikely that most CPAs would have this knowledge or experience. I suggest you find a local employer retirement plan specialist in your area. These are typically identified as Third Party Administrators. This is a busy time of the year and this will likely involve significant cost.

If you have a paper trail of the CPA making these incorrect recommendations there may be causes of action to recoup any losses.