2015 COLA Limits

The IRS has released the cost-of-living adjustments (COLA) applicable to the dollar limitations for qualified plans (and other items) for the 2015 tax year. The regulations places limits on the contributions to 401k plans and IRAs. These limits are adjusted annually for cost-of-living increases.

IRS Limits 2015 2014
401(k) deferrals/catch-up $18,000/$6,000 $17,500/$5,500
Compensation defining highly compensated employee $120,000 $115,000
Compensation defining key employee/officer $170,000 $170,000
Defined contribution plan limit on annual additions $53,000 $52,000
Maximum compensation limit for allocation and accrual purposes $265,000 $260,000
IRA contributions/catch-up $5,500/$1,000 $5,500/$1,000

 

Key Employees Defined for top heavy testing

Pursuant to IRC 415(i)(1), a key employee is any employee who, during the preceding plan year (exception for first plan year, use the current year):

  • was a more than 5% owner of the employer;
  • was a 1% owner of the employer having an annual compensation of more than $150,000; or
  • was an officer or the employer and received compensation greater than $170,000.

With respect to the 5% and 1% ownership tests, certain attribution rules apply with regard to family members, certain trusts or other entities.

There are limitations on how many officers may be considered key employees, as illustrated in the following chart:

 

Number of Employees Maximum Number That May Be Considered Officers
1-30 No more than 3
31-499 10% of actual number of employees
500 or more No more than 50

Highly Compensated Employees Defined for ADP/ACP Testing

Pursuant to IRC 414(q), a highly compensated employee (HCE) is any employee who:

  • was more than 5% owner of the employer during 2015 or 2014; or
  • received compensation from the employer in excess of $115,000 for 2014. (The employer may elect to limit the number of employees in this category to those who are in the top 20% of employees for 2014).

Compensation for defining HCE’s is all compensation actually received, plus amounts deferred because of a 401)k) plan, cafeteria plan or tax sheltered annuity plan. It includes all salaries, fees, commissions, bonuses and tips, even though the plan’s definition may not include these for purposes of allocating the employer contributions. The compensation used for ADP testing, however, may exclude 401(k) plan deferrals and cafeteria salary deferrals if the 401(k) plan so provides. Compensation in the 401(k) plan may be excluded for testing purposes.

The 401(k) salary deferral limit for 2015 is $18,000.

Compensation greater than $265,000 for 2015 will not be considered for all plan purposes.

Click here to learn about Key Employees for top heavy testing.

Roth IRA Conversion Rules

Owner must pay taxes on pretax amounts converted

When converting IRA assets to a Roth IRA, the IRA owner must pay tax on all pretax (deductible) assets. Although the assets are taxed, they are not subject to the 10 percent early distribution penalty tax if properly converted into a Roth IRA.

IRA owners must include all pretax assets that are converted to Roth IRAs in their taxable income (but no 10 percent early distribution penalty tax) (IRC Sec. 408A(d)(3)(A)(i) and (ii)).

Form 1099R and Form 5498 Reporting Applies

An IRA distribution that is directly converted to a Roth IRA is reported on Form 1099-R, Box 7, using distribution code 2, Early distribution, exception applies (for IRA owners under age 591⁄2), or code 7, Normal distribution (for IRA owners age 591⁄2 and older). A financial organization that receives a direct conversion reports the amount as a conversion contribution in Box 3 of Form 5498. The 60-day and one-per-12-month rollover restrictions do not apply.

The distributing IRA financial organization must send Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., to the IRS and the individual receiving the distribution.

Form 1099-R generally must be submitted to the IRA owner by January 31 and to the IRS by February 28 if filing on paper, or March 31 if filing electronically.

Conversions Included in Income

An individual generally must include in taxable income in the year the converted assets are distributed from the Traditional IRA any amounts consisting of pretax contributions (salary deferrals, employer contributions, or deductible IRA contributions).

EXAMPLE: Barb has a Traditional IRA to which she has made only deductible IRA contributions. In 2015, Barb decides to convert her Traditional IRA to a Roth IRA. The taxable amount of the Traditional IRA assets converted is $30,000. Barb will include $30,000 in income in 2015.

Conversion of Property

When individuals receive property (such as shares of stock) as part of a Traditional IRA distribution to convert to a Roth IRA, that same property must be converted. The financial organization must be able to take legal title to the property.

Reporting the conversion on your personal tax return

Report the taxable part of the distribution on lines 15a and 15b of Form 1040.

File Form 1099R, which is provided by the IRA custodian, with your 1040.

Year 2015 Table for qualifying for Roth IRA Contributions

This table shows whether your contribution to a Roth IRA is affected by the amount of your  modified AGI as computed for Roth IRA purpose.

If your filing status is… And your modified AGI is… Then you can contribute…
married filing jointly or qualifying widow(er)

 < $183,000

 up to the limit

 > $183,000 but < $193,000

 a reduced amount

 >  $193,000

 zero
married filing separately and you lived with your spouse at any time during the year

 < $10,000

 a reduced amount

 > $10,000

 zero
single, head of household, or married filing separately and you did not live with your spouse at any time during the year

 < $116,000

 up to the limit

 > $116,000 but < $131,000

 a reduced amount

 > $131,000

 zero

 

For 2015, your total contributions to all of your traditional and Roth IRAs cannot be more than:

  • $5,500 ($6,500 if you are age 50 or older), or
  • your taxable compensation for the year, if your compensation was less than this dollar limit.

The IRA contribution limit does not apply to Rollover contributions.

Additional resources

ROTH IRA LLC Contribution Facts

  • Contributions can be made if you have earned income
  • You contribute already taxed funds (after-tax funds) to a Roth IRA
  • You cannot take a tax deduction for your Roth IRA contribution like you can for a Traditional IRA
  • You can make Roth IRA contributions both before and after age 70 ½ whereas Traditional IRAs cannot accept contributions after you reach age 70 ½.
  • Qualified withdrawals are income-tax free (a withdrawal made after any Roth account has been established for 5 years and the Roth owner is over the age of 59 ½ or qualifies for the first-time home buyer exception or the distribution is due to the account owner’s death or disability)
  • You can also have and contribute to a spousal Roth IRA, based on your income even if your spouse has no earned income
  • Withdrawals of converted amounts may be subject to the 10 percent early distribution penalty if the 5-year exclusion period has not been met (this is a separate 5-year period from the one noted above) and the Roth owner is under age 59 ½ at the time of the withdrawal
  • Roth IRAs are exempt from Required minimum distributions for owners only
  • Roth IRA designated beneficiaries can stretch distributions over their lifetimes just like traditional IRA beneficiaries
  • All contributions and distributions must flow through the Roth IRA not the LLC.

401k Business Financing C-Corp vs. S-Corp

C-Corp vs. S-Corp:

In terms of taxes the choice between a C-Corp and an S-Corp will really depend on your particular circumstances and ultimately what you make.  While some advisors will almost always recommend an LLC/S-Corp over a C-Corp there are certain advantages of a C-corporation generally – see for example, the advantage discussed in the following article: http://www.legalzoom.com/incorporation-guide/corporate-tax-advantage.html   As a general matter, those advisors will make such a recommendation because of the perception that C-Corporations are subject to a “double tax” (where the “double tax” refers to the fact that the corporation must pay tax on its income and any corporate profits distributed to the stockholders are subject to capital gains tax).   While this may be generally true, it is worth noting that with respect to our 401k business financing plan (i) any double taxation effect is mitigated by the fact that any dividends paid with respect to the stock held in your 401k will paid to your 401k on a tax-deferred basis; and (ii) any taxable income at the corporate level can be reduced by a reasonable salary paid to you as an employee of the corporation (since this would be an expense to the corporation).  Ultimately, if you want to use your retirement funds to finance the business the business must be organized as a C-corporation.  As such, perhaps a better comparison would be (i) the cost to access to your retirement funds, vs. (ii) the cost to obtain other types of financing vs. (iii) the taxes and penalties that you would owe if you simply withdrew the funds (often 40% of the distribution).  For example, consider the costs of our plan vs. a $100,000 loan with a 7 year term at an interest rate of 7%.  With our plan, our set-up fee and annual fee over 7 years will total $7,000 plus an additional estimated costs of $4000 for annual valuations and if needed premiums for a fidelity bond (estimated total: $11,000).  With the loan, you would pay over $26,000 in interest (see calculator at https://smallbusiness.yahoo.com/advisor/business-tools/loan-calculator).

After-Tax Contributions

For taxable years beginning on or after January 1, 2007, PPA removes the restriction that required the receiving plan to be of the same type as the distributing plan. Plans eligible to receive after-tax assets, plan permitting, are governmental 457(b) plans, IRC Secs. 401(a) (including solo 401k plans for the self-employed), 403(a), and 403(b) plans, and IRAs. While individuals must directly roll over after-tax assets between eligible retirement plans, they can indirectly roll over after-tax assets from retirement plans to IRAs.

Some 401(k) plans including solo 401k plans may allow employees to make additional contributions to the plan on an after-tax or nondeductible basis. All earnings on such contributions are tax-deferred. The plan documents will specify whether this option is available to participants.  As a solo 401k provider, My Solo 401k Financial offers a solo 401k plan that allows for after-tax contributions.

Planning and Distribution Strategy for my Solo 401k

Doing some longer term planning trying to figure out a distribution strategy for my Solo K.   Presently it’s worth about $600K, $500K in rental real estate and $100K in cash.

My wife is 55 and I’m 54.  We intend to work at least the next year.   The business associated with the 401K is doing better than I expected, which only means I’m working more than I wanted…

A couple of questions:

  • Am I correct in assuming there is no way to do a 72t early distribution since that would require us to quit, and end the justification for the Solo K?

ANSWER:

Good question. 72t periodic distributions are not as favorable to Solo 401k plans as they are to IRAs. I personally think that this is the only instance where the solo 401k is not as advantageous as an IRA. To learn more about the 72t Substantially Equal Periodic Payment Rules, click here.

  • We do expect to have at least a year or two with little to taxable income before retirement age, a perfect time to consider this, if possible.

2) Now fast forward to year 2020 when we will both be able to take normal distributions.  Can the 401K outlive the business?   If not, is the only solution to liquidate the property and rollover to an IRA to avoid a huge tax hit?

ANSWER:

I’m not aware of any language in the code that says a solo 401k must be terminated once the self-employed business sponsoring the plan closes its doors. On the other hand, pursuant to IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), contributions to a solo 401k may only be made if the individual generates self-employment income from the business sponsoring the solo 401k. As such, as long as you cease making contributions to the solo 401k once the self-employed business or self-employment ceases, one can continue to with the solo 401k.

Outside of the 401K we have another $250K of rental property.   What we want to figure out eventually is a way to strip off the rental income to retire early without selling any of the property.   But the 401K has more than half of the income stream.

3) I figure the worst case scenario is we have to wait to 59 1/2 and take distributions based on cash flow, keep the business until we are ready to liquidate (or distribute) the property.

Could not find many “FAQs” on the distribution side of the Solo K.

ANSWER:

Please click here to read my blog post on taking distributions from a solo 401k.

 

 

Contribute to IRA LLC and Self-Directed 401k MAGI Rules

I’m a business attorney in Texas and I have utilized your services in the past to set-up Self Directed 401(k)’s for my clients. I have a quick question regarding a contribution scenario:

QUESTION 1:

Can a husband utilize profit sharing from side business to increase his contributions even though he has a day time job?

ANSWER: Yes, provided the rules outlined in the following link are satisfied.  See following link for more on this. http://www.mysolo401k.net/multiple-retirement-plan-solo-401k-contribution-rules/

 

QUESTION 2:

Finally, how would these 401k contributions effect the deduct-ability of an IRA LLC contribution if we were to set those up through your firm as well?

ANSWER:  See below charts for this.

I’m making a late year push to get several clients to set up self directed 401k accounts and I plan to utilize you services in a similar manner as last year. It was very efficient.

Table 1-2. Effect of Modified AGI1 on Deduction if You Are Covered by a Retirement Plan at Work

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.
IF your filing
status is …
AND your modified adjusted gross income (modified AGI)
is …
THEN you can take …
single or
head of household
$59,000 or less a full deduction.
more than $59,000
but less than $69,000
a partial deduction.
$69,000 or more no deduction.
married filing jointly or
qualifying widow(er)
$95,000 or less a full deduction.
more than $95,000
but less than $115,000
a partial deduction.
$115,000 or more no deduction.
married filing separately2 less than $10,000 a partial deduction.
$10,000 or more no deduction.
1 Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI) , later.
2 If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore, your IRA deduction is determined under the “Single” filing status).

Table 1-3. Effect of Modified AGI1 on Deduction if You Are NOT Covered by a Retirement Plan at Work

If you are not covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.
IF your filing
status is …
AND your modified adjusted gross income (modified AGI) is … THEN you can take …
single,
head of household, or
qualifying widow(er)
any amount a full deduction.
married filing jointly or separately with a spouse who is not covered by a plan
at work
any amount a full deduction.
married filing jointly with a spouse who is covered by a plan
at work
$178,000 or less a full deduction.
more than $178,000
but less than $188,000
a partial deduction.
$188,000 or more no deduction.
married filing separately with a spouse who is covered by a plan
at work2
less than $10,000 a partial deduction.
$10,000 or more no deduction.
1 Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI) , later.
2 You are entitled to the full deduction if you did not live with your spouse at any time during the year.
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