Solo 401k Employer Contribution

The profit sharing will end up being 20%, since the limit is 25% of

*net* earnings, after the deduction for the profit-sharing.

I have not researched this but I suppose that once you have an employee, you can no longer contribute to your Solo 401k, you would have to set up an allowed plan for the new situation.

-Mark Bole

The calculation on the employer side is a bit more complex, because you have to subtract off the employer side of Social Security and Medicare. Even then there's a wrinkle in the calculation. You can follow the instructions on form 1040 SE (lines 3-6), or follow Step 1 in this Fidelity worksheet (it's the same calculation):

There are other limits, though they rarely come into play. The rest of the Fidelity worksheet will walk you through them.

Yes, but you might also have to handle it as a full-blown 401(k) plan, not a solo plan. (Not sure about the conversion machinery, other than the fact that you'd have to file a full 5500 form annually.)

This depends on whether the other person you bring on is really an employee or a "member" (the LLC term for a partner). Solo 401(k) plans are for owners and their spouses, not just for individuals and their spouses. (Note though that many solo 401(k) providers will not deal with multiple owners - another fact to keep in mind when selecting a plan.)

There's "employer" and "employee". The "employee" can choose to contribute any amount of wages up to $15.5K ($20.5K if over 50). The profit sharing portion is determined by the "employer" (the LLC), not the employee. Note that in addition to profit sharing, you can set up the plan to do "employer matching", so the less an employee chooses to contribute, the less the "employer" contributes - this gives more control to the employees.

See above on members vs. employees.

Mark Freeland snipped-for-privacy@sbcglobal.net

@Mark Bole = You are incorrect. I can contribute 25% because I am set up as a corporation (S Corp) and not set up as a sole proprietor. 20%

Freeland - Thanks Mark for your feedback. That was informativeand I realize that it is never as basic as it seems. Let's take the simple example from the worksheet that you referenced. -->100k Business Net Profits. (line 1)

The salary deferral (15.5k) from the employee makes complete sense. The next part is Maximum Profit Sharing. (Lesser of lines 7,8, and 9)

Line 7.... (50% adjusted Net business profits after salary deferral) - I assume this is probably what you were referring to about other limits that don't often come into play. Line 9.... No problem, I get that.

Line 8 is where I have the issue. Why is that 20% of the adjusted Net Business Profits and not 25%???

The worksheet even states on the first page that you can contribute up to 25% of compensation. I realize that you can only do 20% set up as a sole proprietor. Maybe there is a different form?

Thanks,

Phil

calculation):

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Phil, this 25%/20% question comes up a lot. It's 20% because you don't include the contribution itself when calculating the 25% limit. You're able to contribute 25% of earned income, but "earned income" deducts out the SEP/401k contributions...that is a deductible business expense at the entity level., even if the "entity" is a fiction (meaning, even if you're a sole proprietor).

In effect your P&L ends up looking like this: $50,000 net profit for the business ($10,000) compensation expense - retirement plan = $40,000 earned income

$10,000/$40,000 = 25% $10,000/$50,000 = 20%

We think in terms of the $50,000 figure, so use 20%. But the rule on contribution limits is written in terms of the $40,000 figure, i.e. 25%.

Incidentally the $50k figure would be AFTER deducting out half of your self-employment tax. The online calculators should all do this, like the one on Fidelity's site.

-Tad

PS if you are a math person note that some simple algebra gets you to the 20% figure.

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Neither you nor the employee can participate in a solo 401k should you ever hire an employee. Solo k's are offered ONLY to businesses that solely employ partners and their spouses.

If your business is doing well, a SEP may have been more suitable. There are many facets, but one of the advantages of the 401k is that you can contribute 100% of salary (up to the limit). A SEP only allows

25% deferral. However, if your earnings are high enough, the contribution limit becomes the deciding factor and the 401k loses that advantage.

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[...]

Just to add to the complexity, I think Flip was right when he said I was wrong.

For a sole proprietor, yes the deduction limit is (.25 / (1 + .25)) 20% for the reason Tad mentioned. However the OP mentioned that he elected to be taxed as an S-corp, which means he has wages, not self-employment income. There is some support for this at the T. Rowe Price web site, where a table shows that the max (deductible) solo 401k contribution for an unincorporated business with net profit of $50K is

$24,794 = $15,500 salary deferral plus 20% of ( ($50K x .9235) less 1/2 of 15.3% self-employment tax on ($50K x .9235) )

while the same number for an incorporated business is

$28,000 = $15,500 salary deferral plus 25% of $50K

Because the S-corp is pass-through for tax purposes, in the end I think it will come out the same. In other words, $50K net profit for an S-corp is not the same thing as $50K net profit for sole proprietor (because the corporation is still paying and deducting the wages plus 1/2 share of FICA plus the profit-sharing contribution).

Frankly I have no experience with, nor can I find much info about, solo

401k's for S-corps. This is not a well-documented topic, based on multiple on-line and printed materials I researched.

This question might get a better response in misc.taxes.moderated.

-Mark Bole

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[...]

Although with a 401k while the contribution limit may be 100%, you can still only deduct 25%.

-Mark Bole

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