401(K) sole-proprietor with employees

[wiiabenefits]

A client set up a 401(k) in 2017 for her LLC which is taxed as a sole proprietor. She has 6 full-time employees and has set up the 401(k) so there will be no employer contributions, only employee contributions.

Two questions:

1) What date does she have to fund her "employee" portion for 2017? By December 31, 2017?

2) Because there will be no employer contributions to the plan,  the plan must be set up as a traditional 401(k).  That means she must have it tested to be sure it is not top heavy. Is that testing typically done on a projected basis so she does not overfund her contribution before December 31?

[ETA Consulting LLC]

The plan is not precluded from becoming top heavy merely because it is designed to be deferral only.  I'm sure there is language within the Basic Plan Document that prescribes for the TH Minimum in the event the plan becomes Top Heavy.  

For the owner's deferral, her election must be in place by December 31st (e.g. the last day of the taxable year); to be funded when her accountant figures her final compensation on which to make the deferral.  

Good Luck!

[Bird]

I'm a little confused and unsure about what you are asking.  Not to be insulting, but since an awful lot of people throw out the term "top heavy" when they mean something else, are you sure you mean "top heavy" and not "401(k) non-discrimination testing?"

Top heaviness is not something you test "to be sure it is not top heavy," it's something you test... and then if it is (top heavy - more than 60% of assets belong to the owner) you have to be sure to provide a minimum 3% employer contribution.  If the owner does not want to make that contribution then it would certainly be a good idea to run a preliminary test to see if it would be (!)

For the basic ADP non-discrimination test, you can do a projected test and try not to fail, but it's not that big of a deal to fail because you just do refunds the next year.

Hope that helps, maybe if you clarify we can zero in on a better answer.

[Lou S.]

If the owner's deferral is more than 60% of the total deferrals for the first year the Plan will be top-heavy and require a 3% employer contribution, unless something really screw goes on with the gain loss.

The Plan is also subject to ADP testing. If the plan is using prior year testing the owner can put in 5% of pay (plus the catch-up if she's eligible) and not fail testing. If you are using current year testing you follow those rules.

It's possible your owner could get the worst of all worlds by making a large 401(k) contribution that causes the Plan to be both Top-Heavy and trigger large refunds.

As Bird suggest running some projected tests would be prudent.

 

 

[wiiabenefits]

I mentioned top heavy because I did not want an excessive contribution on her part to trigger the 3% contribution.  She is adamant she does not want to make a company contribution.  It's not the plan I would have steered her to but she chose to start this plan without benefit of my advice.

The estimated 2017 profit of the her sole proprietorship is $250K. Just to clarify the timing aspect of her contribution, pursuant to Reg 1.401(k)-1(a)(6), she needs to make her election by Dec 31, 2017.

Does it need to be paid by Dec 31,  2017 or April 15, 2018 (or the extended due date of her 2017 Form 1040)?

 

[Belgarath]

For the first year of a new profit sharing plan, you must test for top heavy on an accrual basis.

[Lou S.]

And the determination date for year one and year two will be the last day of the first plan year.

[Tom Poje]

If it helps, here is how one write up describes it

https://www.irafinancialgroup.com/solo-401k-contribution-deadline.php

Sole Proprietorship

Employee Deferral

In the case of a sole proprietorship, a business owner under the age of 50 may make employee deferral contributions up to $18,000 for 2017 (an employee over the age of 50 may make a $6,000 annual catch-up contribution for an annual deferral contribution imitation of $24,000). An Employee must elect to make the employee deferral contribution by December 31 of the year. However, the employer deferral contribution can be made up until the tax-filing deadline.

The employee deferral contribution can be made using pre-tax and/or after-tax (Roth) funds.

....................

so I'm not sure your deferral election can be "Whatever amount such that when the top heavy test is run the plan will be less than 60%", that is not definitely determinable. I guess you could specify an exact %, e.g. "so that the top heavy % is 55%, but never more deferral than permitted by the regulations for the year" arguably, since the deferral is required, even though not deposited by 12/31 would be included in the test (as opposed to a discretionary ps contribution, which in your case there are no plans for any way).

 

[wiiabenefits]

What about the 7-day deposit rule for employee deferrals with plans less than 100 participants? Wouldn't her "employee" portion be subject to that rule?

https://www.dol.gov/opa/media/press/ebsa/EBSA20100056.htm

 

[Lou S.]

A sole-proprietor doesn't "know their pay" until they file their taxes. At least that's the explanation I've heard as to why sole-proprietors can make their 401(k) contribution as late as 10/15 the following year and not be a late contribution for the 401(k) timing rules.

[Bird]

OK, sorry to doubt you about what you meant.  And welcome to the board.

As far as the 7-day deposit rule, first keep in mind that that is not a tax issue, so there is no doubt a sole prop could deposit 401(k) contributions by the due date of their tax return, with extensions, and deduct the contributions.  The question then is whether they are "late" for purposes of prohibited transaction rules, and as Lou S notes, there is a school of thought as well as an IRS (or DOL?) statement of some sort that about the clock starting to run when income is determined.  However, I maintain, and maybe I'm on an island, that if you elect "$10,000" or whatever dollar amount, that there is no need to determine income to determine the contribution - you know damn well what the contribution is, it's $10,000, so there is no tie-on with income.  I believe the "when income is determined" clause applies,  or at least should apply, to percentage elections.  But I'm probably crazy or at least weird.  Anyway I always recommend getting contributions in by Jan 10 or so to be safe.

[david rigby]

Note that TH testing is based on the total value of the accounts, not the annual contribution.  Thus, if TH in one year, the plan might be TH the next year even if the owner makes no contribution. 

As stated above, a TH deferral-only 401(k) plan is the "worst of all worlds".  If so, this owner needs some good consulting advice.

[Tom Poje]

I don't think it matters if the owner elected a $ amount or percentage. even the preamble to the regs has (emphasis mine)

One commentator asked for clarification of the interaction between these timing rules and the rule under the regulations that treats a self-employed individual's earned income as being currently available on the last day of the individual's taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner's draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual's actual earned income for the relevant period.

........

I read that to say you can take advantage of things and defer before your actual income is determined, but there is no requirement to do so. the final regs merely clarified the fact you don't have to wait until the last day of the individual tax year (but apparently you can).

 

 

[Bird]

Sorry Tom but I don't think that is the issue at hand; that was about funding before the last day of the year when income is deemed to be earned.  There is some, I think, informal guidance that hints at when income is available (the segregation date for when self employed deferrals become plan assets) but I can't find it, although I'm sure I was a participant in such a thread.  And I may have a mental block about this so sorry for dragging it out.

[Tom Poje]

and if it turns out Sched C income is less than 10,000 or even negative, then what?

[Bird]

Then it's a 415 excess and you deal with it accordingly.

[Tom Poje]

or, as the preamble implies, if you don't take advantage of the ability to defer on draws then it won't be an issue because you will know what your income is because you waited until the comp was determined.!

a quick (but not exhaustive search on the internet has the following comments)

I couldn't find any that indicate deferral have to be in earlier than April 15 (or later with extension)

the only caveat any of these make is 'if comp is known' then it has to be in within a few days.

which, I guess, if you defer a % and you are taking a draw you would need to put in, but I suppose your election could specify 'not on draws'

 

 

This rule applies, even if the amount of your earned income is not determined by the end of your entity’s tax year. This election timing rule means that you must make your deferral election without knowing for sure how much compensation you will have for plan purposes for the plan year.

Deferral Deposits

The above rules also apply to deferrals made by any self-employed person. Generally, the date the clock starts ticking is the date your distributive share of earned income is determined. If you defer from draws or guaranteed payments, the clock starts ticking for those deferrals on the date the draw or guaranteed payment otherwise would be paid to you.

http://ebrworld.com/deferral-election-and-deposit-rules-for-the-self-employed/

 

 

Is there a deadline to make salary deferrals into the Individual 401k?

For a sole proprietorship, partnership or an LLC taxed as a sole proprietorship the deadline for depositing salary deferrals into the Individual 401k is generally the personal tax filing deadline April 15 (or October 15 if an extension was filed).

http://www.individual401k.com/contribution-limits-soleproprietorship.html

 

With the "individual(k)," a sole proprietor can make salary deferrals up to $18,000 and contribute up to an additional 20% of net self-employment income -- for a maximum contribution of $53,000 in 2015. There's also a $6,000 catch-up contribution for those age 50 and older. Contributions are tax-deferred and tax-deductible. And you can take loans from your account just as you can with a traditional 401(k).

The 401khelpcenter.com has a list of financial firmsproviding 401(k)s for sole proprietors.

You must establish your plan by December 31 and fund it by April 15.

https://www.kiplinger.com/article/retirement/T047-C000-S001-do-it-yourself-retirement-plans.html

 

From the Department of Labor’s perspective with respect to determining late deposits of employee deferrals, deferrals for self-employed individuals must be deposited as soon as they can be reasonably segregated from the business’s assets. The DOL’s safe harbor for plans with fewer than 100 employees also applies. Therefore, as long as the deferrals are transmitted within seven business days after the amounts became payable, the contributions are deemed timely made. From the IRS’ perspective, in no event can the deferrals be deposited after the deadline for filing the business’s tax return, plus extensions.

http://www.napa-net.org/news/technical-competence/case-of-the-week-salary-deferral-elections-for-the-self-employed/

 

Employee Deferral

In the case of a sole proprietorship, a business owner under the age of 50 may make employee deferral contributions up to $17,500 for 2013 (an employee over the age of 50 may make a $5500 annual catch-up contribution for an annual deferral contribution imitation of $23,000). An Employee must elect to make the employee deferral contribution by December 31 of the year. However, the employee deferral contribution can be made up until the tax-filing deadline.

http://www.irafinancialgroup.com/wp/solo-401k-contribution-deadline/

[wiiabenefits]

In this particular instance, there are a half dozen employees so the rules of a solo 401(k) wouldn''t apply here, I'm thinking.  My client's situation underscores the trouble a client can get into when they don't seek advice before they jump into something.

 

 

[RatherBeGolfing]

1 hour ago, wiiabenefits said:

In this particular instance, there are a half dozen employees so the rules of a solo 401(k) wouldn''t apply here, I'm thinking.  My client's situation underscores the trouble a client can get into when they don't seek advice before they jump into something.

 

 

There are no special rules for a solo 401(k), it is just a marketing term for a one participant plan.  The reporting is a little different but the "rules" are the same.  

With this kind of setup, I would assume that ADP testing would be an issue as well, not just possible TH issues?

Is the owner/principal catch-up eligible?

[Bird]

Tom, I am not disputing at all the idea that a self employed has until the due date of their tax return to complete their deferral contributions for tax purposes, in fact, I said exactly that:

"...there is no doubt a sole prop could deposit 401(k) contributions by the due date of their tax return, with extensions, and deduct the contributions."

But the issue that I thought was at hand is how the DOL sees it from the "late deposit" standpoint, and the quote below is somewhat responsive, but it's more about partners than sole proprietors, IMO; if anything it tightens up the argument that they are due sooner than generally thought - "If you defer from draws."  What if you don't "defer from draws?"

20 hours ago, Tom Poje said:

Deferral Deposits

The above rules also apply to deferrals made by any self-employed person. Generally, the date the clock starts ticking is the date your distributive share of earned income is determined. If you defer from draws or guaranteed payments, the clock starts ticking for those deferrals on the date the draw or guaranteed payment otherwise would be paid to you.

But look, it doesn't appear the DOL is on the warpath against sole proprietors who delay their deposits.*  I'm just being obstinate and saying they haven't "blessed" the idea that it's no problem.

*They have better things to do, like encourage VFCP applications for lost earnings that are worth a few pennies.

[RatherBeGolfing]

9 minutes ago, Bird said:

They have better things to do, like encourage VFCP applications for lost earnings that are worth a few pennies.

Don't forget "encouraging" plan sponsors to make house calls in order to locate missing participants, that is one of my new favorites

[wiiabenefits]

7 hours ago, RatherBeGolfing said:

Is the owner/principal catch-up eligible?

Yes.

[RatherBeGolfing]

5 minutes ago, wiiabenefits said:

Yes.

Ok.  Since it is 401(k) only, your ADP test will probably limit the amount of deferrals your owner can make.  If the owners deferrals are going to be restricted anyways,  how about restricting the owners deferrals in the document to something like $100? Tthis would trigger catch-up at $101. The owner could defer the full $6100, with only $100 subject to ADP testing. This also works in your favor for top heavy because catch-up contributions are not included when you determine highest contribution rate for the top heavy minimum (but it is included when calculating 60% for TH determination).  So even if you had to make a TH contribution, it would be really small because it is determined only using the $100.

 

[Mike Preston]

I would collect projected census for 2017 and go from there.