One of the more confusing tax aspects of establishing a Solo 401(k) plan is the deadline for making either employee deferral or employer contributions in a given taxable year. This article will explore the deadlines for making contributions in 2023 for the 2022 taxable year, based on the various business entity types. However, before we get into the contribution deadline rules, the article will briefly describe what a Solo 401(k) plan is and who is eligible to establish one.
- If you are self-employed or have a small business with no full-time employees, the Solo 401(k) is the best retirement plan option
- If you haven’t set up a plan yet, you still can, and receive tax deductions for 2022
- SECURE Act 2.0 adds extra incentive for sole proprietors and single member LLCs to get started now
What is a Solo 401(k)?
The Solo 401(k) plan is not a new type of 401(k) plan. A Solo 401(k) plan, also known as an Individual 401(k) or Self-Employed 401(k) plan is a retirement plan that must be adopted by a business that does not have any non-owner full-time employees. It is perfect for any sole proprietor or small business with no-full time employee. A non-owner full-time employee is any business non-owner including spouses that does not work more than 1000 hour during the year or three consecutive years of 500 hours.
Types of Solo 401(k) Contributions
The most popular benefit of the Solo 401(k) plan is the high annual maximum contributions. In other words, with a Solo 401(k) plan, one can reach his or her maximum contribution limitation faster than a SEP IRA since a SEP is only a profit-sharing plan. The Solo 401(k), on the other hand, is a profit-sharing plan, but it also has the employee deferral feature, which will be highlighted below.
There are generally two types of categories of Solo 401(k) type contributions:
Solo 401(k) Employee Deferral Contribution
Anyone with access to a 401(k) plan can make the employee elective deferral contribution. The majority of employees make pretax contributions, which offer a tax deduction.
Under the 2022 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum annual employee deferral contribution in the amount of $20,500 ($22,500 for 2023). That amount can be made in pretax, after-tax or Roth. Whereas, for plan participants who have reached age 50, you can make a maximum annual employee deferral contribution in the amount of $27,000 ($30,000 for 2023). The employee deferral is made on a dollar-for-dollar basis.
Solo 401(k) Employer Profit Sharing Contributions
What makes the Solo 401(k) unique, is that you may also contribute as the employer. This is known as profit sharing contributions.
Unlike the employee deferral, a percentage of your income is used to determine the amount you may contribute as the employer. You may contribute up to 25% of you self-employed compensation, unless you are a sole proprietor or single member LLC, in which you may contribute up to 20%.
Employer contributions are essentially a percentage of the plan participant’s W-2 amount, guaranteed payment, or net Schedule C amount, depending on your business type. They are made by the business and are also 100% elective, but must be made prior to the business filing its tax return. Profit sharing contribution must be made pretax, but can be converted to Roth if your plan documents permit.
Combining the Two
The sum of the two contributions cannot exceed the IRC 415 limit for 401(k) plans. For 2022, the limit is $61,000 if you are under 50 and $67,500 if you are age 50 or older. Those limits increase to $66,000 and $73,500 respectively in 2023.
An example: A plan participant under the age of 50 earned $50,000 in W-2 salary. He or she would be able to make a maximum employee deferral of $20,500 (pretax or Roth) plus a profit sharing contribution equal to 20% of the W-2 amount, or $10,000, for an aggregate contribution of $30,500. Since that amount is less than the IRC 415 amount for 2022, the contributions will be respected for tax purposes.
However, in order to take advantage of the opportunity to make both employee deferral and employer profit sharing contributions for 2022, the Solo 401(k) plan would need to be adopted in the 2022 taxable year (see below about new rules for 2023).
The SECURE Act 1.0
Thanks to the SECURE Act, which was passed in December 2019, starting in 2020, a business can now establish a Solo 401(k) plan in a current year and still make some contributions for the previous year. The only caveat is that in such a scenario where a business has established a Solo 401(k) plan in 2023 and wants to make contributions for the 2022 taxable year, only employer profit sharing contributions can be made for 2022. You cannot make the employee deferral.
If the plan was established prior to this year, the business, other than a corporation or partnership (see below), would generally have the option to make both employee and employer contributions in 2023 for the 2022 taxable year.
The 2022 Solo 401(k) Plan Contribution Rules for a Sole Proprietor in 2023
Any business that operates without an entity type of deemed to be treated as a sole proprietorship. In other words, the business has no entity shielding it from liability and typically operates in the name of the owner. However, an owner can elect to file to have the business operate in a different name (“DBA”).
A sole proprietor can establish a Solo 401(k) plan for the 2022 taxable year up until the business owner files his or her federal income tax return (Form 1040). IRS Form 1040 is due April 15, 2023, or October 15, 2023, if the individual filed for an extension. Hence, a sole proprietor can set up a Solo 401(k) plan for the 2022 taxable year up until October 15, 2022, so long as they have filed for an extension.
However, only employer profit sharing contributions (20% of the net Schedule C amount) would be permitted to be made for the 2022 taxable year since the plan was not established in 2022.
The 2022 Solo 401(k) Plan Contribution Rules for a Single Member LLC in 2023
An LLC reports its business income using Schedule C, which is a schedule to the Individual Income Tax Return (Form 1040). In 2023, a business owner that operates his or her business as a single member LLC, can establish a Solo 401(k) plan for the 2022 taxable year up until the business owner files the federal income tax return 1040. IRS Form 1040 is due April 15 ,2023 or October 15, 2023, if the individual filed for an extension.
Just like the sole proprietorship, only the 20% employer profit sharing contribution can be made when establishing the plan during the next taxable year.
SECURE ACT 2.0 Changes for Sole Proprietors and Single Member LLCs
Section 317 of SECURE Act 2.0 is a provision which says “an employer may establish a new 401(k) plan after the end of the taxable year, but before the employer’s tax filing date and treat the plan as having been established on the last day of the taxable year.” Further, “Section 317 allows these plans, when they are sponsored by sole proprietors or single- member LLCs, to receive employee contributions up to the date of the employee’s tax return filing date for the initial year.”
Therefore, thanks to the passage of the new legislation, those businesses that are set up as a sole proprietor or single member LLC can now make employee contributions, in addition to the usual employer profit sharing contribution and take full advantage of the contribution limits.
The 2022 Solo 401(k) Plan Contribution Rules for a Partnership in 2023
An LLC with two or more owners is taxed as a partnership for federal income tax purposes. For the 2022 taxable year, a partnership must file IRS Form 1065 (U.S. Return of Partnership Income), as well as the state-related tax form by March 15, 2023, or by September 15, 2023, if an extension is filed.
In 2023, a business owner that operates his or her business as a multiple member LLC or partnership can establish a Solo 401(k) plan for the 2022 taxable year up until the business files Form 1065. Once again, if the plan is established in 2023, only the employer profit sharing contribution can be made for the previous year.
The 2022 Solo 401(k) Plan Contribution Rules for a Corporation in 2023
A C corporation is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. An S corporation is a corporation that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
For the 2022 taxable year, a C corporation is required to file Form 1120 (U.S. Corporation Income Tax Return) as well as the state-related tax form by April 15, 2023, or by October 15, 2023, if an extension is filed. If you have an S corporation, the 1120 is due March 15, or September 15 if an extension is filed.
Once again, with a plan that is established in 2023 by a corporation, only the 25% employer profit sharing contribution can be made for the 2022 taxable year.
The biggest lesson you should take from this article is not to procrastinate when it comes to establishing a Solo 401(k) for your business. When the plan set up during the taxable year you wish to make contributions, you can take full advantage of the generous IRS limits. Of course, there are many obstacles to navigate when starting your own business and setting up a retirement plan may not be near the top of the list. However, for those who started a business last year and were not able to set up a plan, there is still time to receive tax deductions for 2022 by setting up a plan in 2023.
So long as you are eligible, there is still plenty of time to get started. Unfortunately, you may only have the opportunity to make profit sharing contributions. But as they say, some is better than nothing. Establishing the plan now will also allow you take full advantage of the benefits for this year and beyond.
Lastly, thanks to SECURE Act 2.0, if you are a sole proprietor or single member LLC, you can now fully take advantage of the contribution limits, regardless of when the plan was established.