There is a common misconception that only a sole proprietor can establish a Solo 401(k) plan. However, the truth is that anyone that is self-employed, whether they are a sole proprietor or have a business with no non-owner full-time employees can establish a Solo 401(k). This article will explore how the Solo 401(k) rules will work for a business owner that has a C Corporation.
What is a Solo 401(k)?
A Solo 401(k) plan is essentially a 401(k) plan for a business that has no full-time employees other than the business owner(s) and their spouse(s). It is perfect for any sole proprietor or small business with no-full time employees. A non-owner full-time employee is anyone that does not work more than 1,000 hours during the year or three consecutive years of 500 hours.
What is a C Corporation?
A corporation is formed under the laws of a particular state by filing articles or organization with the Secretary of State in the relevant state. A standard corporation is known as a C Corporation. A C Corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This is known as a two-layer of tax or double tax. A C Corporation is not a flow-through entity like an LLC or an S corporation. As a result, it is not the most common entity type for small businesses with no employees.
Ownership of a C Corporation is evidenced through the issuance of stock certificates to shareholders. Shareholders have legal rights to the distribution of corporate profits. An employee of a C Corporation, including any owner, will receive a W-2, which displays the annual income earned from the business.
Types of Solo 401(k) Contributions for a C Corporation
The most popular benefit of the Solo 401(k) plan is the high annual maximum contributions. It 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:
Employee Deferral: The majority of employees make pretax employee deferral contributions which are tax deductible. Under the 2023 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 $22,500 ($20,500 for 2022). That amount can be made in pretax, after-tax or Roth. Plan participants who are at least age of 50 can make a maximum annual employee deferral contribution in the amount of $30,000 ($27,000 for 2022).
Profit Sharing: Through the role as the employer, an additional contribution can be made to the plan in an amount up to 25% of the participant’s W-2. Employer contributions are made by the business and are also 100% elective but must be made prior to the business filing its tax return. Employer contributions are also known as “profit sharing” contributions and must be made in pretax, but can be converted to Roth so long as your plan documents permit. 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.
Total Contribution: The sum of employee deferrals and employer contributions cannot exceed the IRC 415 limit for 2023 which is $66,000 ($61,000 for 2022) or $73,500 ($67,500 for 2022) for persons age 50 and older.
Related: Popular Solo 401(k) Investments
The Solo 401(k) Plan Contribution Rules for a C Corporation
For the 2022 taxable year, a C corporation is required to file IRS Form 1120 (U.S. Corporation Income Tax Return) as well as the state-related tax form by April 15, 2023, or October 15, 2023, if an extension is filed. A business owner that operates his or her business as a C corporation can establish a Solo 401(k) plan for the 2022 taxable year up until the business files Form 1120. However, if you establish the plan after December 31 of last year, you are limited to only the profit sharing side of contributions. This is because you were not able to elect to make employee deferrals before the end of the tax year.
Obviously, if you want to take full advantage of the annual contribution limits, you should establish your plan before the end of the year. Get started now to have your plan ready for this year and beyond.
The Solo 401(k) plan is the most popular retirement plan for the self-employed, including shareholders of a C corporation, that do not have any full-time employees other than the shareholders or their spouses. In addition to high annual contribution options, the plan allows a plan participant to invest in alternative assets, borrow up to $50,000 tax- and penalty-free, max out Roth contributions via the “Mega Backdoor” Roth strategy, plus it has very simple annual administration requirements.