IRA Financial Blog

Is a Solo 401(k) Roth Employer Contribution Tax Deductible?

April 9, 2024

Thanks to the Secure Act 2.0, which became law in December 2022, Solo 401(k) employer profit-sharing contributions can now be made in pre-tax or Roth. This article will explore the tax ramifications for the employee and employee in the case of employer profit-sharing contributions made in Roth. However, before we get into the Solo 401(k) employer profit-sharing contribution Roth rules, it is important to understand what a Solo 401(k) plan is and how the 2024 Solo 401(k) contribution rules work.

What is a Solo 401(k)?

A Solo 401(k) plan” is an IRS-approved retirement plan, which is designed for business owners who do not have any employees, other than themselves and perhaps their spouse. The Solo 401(k) Plan is not a new type of plan. It is essentially a regular 401(k) plan covering only one employee. The Economic Growth Tax Relief and Reconciliation Act of 2001 (EGTRRA) created a strong interest in the Solo 401(k) Plan. EGTRRA added employee deferrals, the loan feature, and Roth contributions to the Solo 401(k) plan making it a far better option for the self-employed or small business owner than a SEP IRA.

Who Can Establish a Solo 401(k) Plan?

The Solo 401(k) plan may be adopted by an individual sole proprietor, or any other business entity, such as an LLC, corporation, or partnership. In general, to be eligible to benefit from the Solo 401(k) Plan, one must meet just two eligibility requirements:

(i) The presence of self-employment activity.

(ii) The absence of full-time employees.

The following types of employees may be generally excluded from coverage:

Employees under 21 years of age
Employees who work less than 1000 hours annually or two years of 500 hours or more
Union employees
Nonresident alien employees

2024 Solo 401(k) Plan Contribution Rules

Under the 2024 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 $23,000 ($22,500 for 2023). That amount can be made in pre-tax, after-tax, or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution. in pre-tax or Roth, based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $69,000 ($66,000 for 2023).

For plan participants over the age of 50, an individual can make a maximum annual employee deferral contribution of $30,500 ($30,000 for 2023). That amount can be made in pre-tax, after-tax, or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution, in pre-tax or Roth, based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $76,500 ($73,500 in 2023).

Solo 401(k) Roth Employer Profit Sharing Contribution & Secure Act 2.0

In the case of a Solo 401(k), employer profit-sharing contributions are a percentage of the plan participant’s net Schedule C income (20%), in the case of a sole proprietor or single member LLC, or 25% in the case of a W-2 corporate employee.

Before 2023, all Solo 401(k) plan employer contributions were required to be in pre-tax. The employer making the employer profit-sharing contribution would receive a tax deduction for making the contribution, but the employee would not recognize any income from receipt of the employer contribution since the contribution was made pre-tax. The employee would be subject to income tax, and potentially a 10% early distribution penalty, upon taking a distribution. Hence, the IRS did not need to force the employee to take into income the pre-tax employer contribution since the employee would ultimately be required to recognize the tax upon distribution.

However, starting in 2023, the Secure Act 2.0, which is included in a 4000+-page, $1.7 trillion spending bill — which would fund the government for the 2023 fiscal year — was unveiled on December 20, 2022. The Secure Act 2.0 was signed into law by President Biden on December 29, 2022. The Secure Act 2.0 contained numerous important retirement rules, including adding the Roth option to 401(k) plan employer contributions. Under the bill, employers may permit employees to elect for some or all of their vested matching and nonelective employer contributions to be treated as Roth contributions under a 401(k), 403(b), or governmental 457(b) plan. This provision would be effective after the date of enactment.

Hence, starting in 2023, a Solo 401(k) plan participant can elect to have the employer make employer profit-sharing contributions in Roth instead of pre-tax. The employer would still be eligible to receive a tax deduction for the employer contribution, but the employee would be subject to income tax on the amount of the Roth employer profit-sharing contribution. The reason for this is that since the Roth employer contribution is after-tax if the IRS did not capture the tax payment on receipt of the contribution by the employee, it would likely lose the right to tax it in the future since qualified Roth 401(k) contributions are generally tax-free.

For example, Lisa has a Solo 401(k) plan which she adopted for her single-member LLC. Lisa is 45 years old and earned $100,000 of net Schedule C income. Lisa is a Roth lover. In 2024, Lisa elected to make employee deferrals of $23,000 all in Roth, and also elected to have the business make employer profit-sharing contributions of $20,000 (20% of $100,000) in Roth. Lisa would be subject to income tax on the $20,000 of Roth employer contributions made by her business.

Items to Consider When Making Solo 401(k) Roth Employer Contributions

Participants must election to designate as Roth.
Roth employer contributions likely starts 5-year clock, if not already started for the year income included.
Tax reporting. Probably appear on Form W-2, box 1 in year contribution made; maybe Form 1099-R. Not clear whether these amounts count for FICA/Medicare taxes.
The employee is responsible for taxes; the employer gets a deduction.
Roth employer contribution shouldn’t be counted as compensation for plan purposes.
Alternatively, Roth employer plan contribution could be done as in-plan Roth conversation and Form 1099R.