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Solo 401(k) Rules & Multiple Member LLC (Partnership)

Solo 401(k) Rules & Multiple Member LLC (Partnership)

The IRS allows any entity type, including an LLC, to establish a Solo 401(k) plan.  The Solo 401(k) plan is essentially a regular 401(k) plan covering a business with no full-time employees other than the owner(s) or their spouse(s). The Economic Growth Tax Relief and Reconciliation Act of 2001 (EGTRRA) helped accelerate the popularity of the plan. Additionally, 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.

 
Key Points 
  • If you qualify, any type of entity can adopt a Solo 401(k)
  • A Multiple Member LLC as an LLC which is owned by two or more members
  • In addition to the employee deferral, one can make a 25% contribution as the employer

Can a Multiple Member LLC Establish a Solo 401(k) Plan?

The Solo 401(k) plan may be adopted by any multiple member LLC with a U.S. business. In general, to be eligible to benefit from the Solo 401(k) Plan, a multiple member LLC, also known as a partnership, 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 that work less than 1000 hours annually
  • Three consecutive years of more than 500 hours
  • Union employees
  • Nonresident alien employees

In sum, so long as the multiple member LLC has no full-time employees other than the owner or spouse (not treated as an employee under ERISA), the business is eligible to adopt a Solo 401(k) plan.

What is a Multiple Member LLC?

A multiple member LLC is an LLC that is owned by two or more members.  Obviously, a single member LLC is an LLC owned by just one party. From a federal income tax standpoint, a multiple-member LLC is treated as a partnership. Both types of LLCs are pass-through entity-types meaning they are not subject to an entity level tax, like a C Corporation.

It does not matter if the LLC is owned by individuals or a retirement plan; because it is treated as a partnership for federal income tax purposes, a multi-member LLC is required to file a U.S. partnership tax return (Form 1065) as well as the corresponding state return. The LLC’s earnings would not be subject to an entity-level tax; instead, taxes “flow-through” to the members.

In sum, a multiple-member LLC must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it passes profits or losses to its members or partners. Each LLC member reports his or her share of the LLC’s income or loss on their personal tax return via a K-1.

Members of an LLC are not employees and shouldn’t be issued a Form W-2. The LLC must furnish copies of Schedule K-1 (Form 1065) to the partner. Pursuant to partnership tax rules, a member’s share of the LLC’s net profit or loss is reported on Schedule K-1 as a “distributive share” item, whereas compensatory amounts that are determined without reference to the LLC’s net income are reported on the K-1 as “guaranteed payments.”

In other words, the amount that can be contributed to a Solo 401(k) plan is based on the guaranteed payment and not the net profits of the LLC.  Generally, neither of these amounts are subject to withholding of income tax or FICA, and the member is responsible for paying the income tax and self-employment tax directly (greatly complicating the worker’s personal tax situation).

Solo 401(k) Contribution Rules & Multiple Member LLC

Any multiple-member LLC that wishes to make high annual tax-deferred or Roth contributions, would benefit greatly from establishing a Solo 401(k). Under the 2022 Solo 401(k) contribution rules, a plan participant can make a maximum annual employee deferral contribution up to $20,500, plus an additional “catch-up” contribution of $6,500 if he or she is at least age 50. This contribution can be made in pretax, after-tax, or Roth funds.

On the profit-sharing side, a multiple-member LLC can make a 25% annual profit-sharing contribution based on the amount of the guaranteed payment received by the LLC based on compensation received. The maximum a Solo 401(k) plan participant can contribute to a plan in 2022, including the employee deferral contribution, is $61,000 or $67,500 if at least age 50.

The main distinction of using a multi member LLC, as opposed to a sole proprietorship or single member LLC, is the percentage used to calculate your profit-sharing contribution – 25% vs. 20%. This means you can reach the maximum allowed contribution with less income.

The primary distinction between adopting a Solo 401(k) plan as a sole proprietor vs a multiple-member LLC or corporation is that the employer profit sharing contribution is 25% versus 20% for a sole proprietorship or single member LLC.

An Example

Barbara, a 45-year-old member of an LLC with one other person, earns $100,000 as a guaranteed payment from the LLC.  Because she is under age 50, she may contribute $20,500 as the employee, plus an additional $25,000 of her guaranteed payment (25% of $100,000) for a total of $45,500.

Note – if the LLC made an employer contribution for Barbara of 25%, it would also need to make an employer contribution to her partner of 25% (based on his or her guaranteed amount). However, employee deferrals are 100% elective.

Solo 401(k) Contribution Deadline – Multiple Member LLC

A multiple member LLC reports income on IRS Form 1065.  The form is due March 15 of the following year, or September 15 if an extension is filed.  A guaranteed payment paid to a member of an LLC for compensation of services is akin to a W-2.  Hence, a member of an LLC should know their annual compensation amount by December 31.

Accordingly, a member who received a guaranteed payment on a K-1 and makes employee deferrals should elect to make those contributions by December 31.  It is good practice to have the contribution deposited or dated by December 31. On the other hand, employer profit sharing contributions, which are made by the LLC for the benefit of the LLC members can be made up until the tax filing deadline (including extensions).

Conclusion

When making contributions to a multiple member LLC is it important to remember the following key points:

   
     
  • Solo 401(k) plan contributions are based on the guaranteed payment amount and not the net profits of the LLC
  •  
  • Employee deferrals should be made by December 31
  •  
  • Employer profit sharing contributions can be made until the LLC files its IRS Form 1065
  •  

If you are self-employed and utilize a multiple member LLC for your business, you should be aware of the contribution limits and restrictions for your Solo 401(k) plan. Maximizing these benefits is an important part of setting yourself up for retirement.

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