The following income is not considered earned income from self-employment; therefore, it does not qualify for participating in a solo 401k plan or for making annual contributions to a solo 401k plan.
- Alimony Pay stemming from divorce
- Earnings and profits from property and investments, such as rental income, interest income, and dividend income
- Deferred compensation
- Income from a partnership for which an individual does not provide services that are a material income-producing factor
- Pass-through income earned by a shareholder in an S corporation is not classified as earned income.
- Retirement income, including Social Security, pension, and annuity income
- Disability pay
- Worker’s compensation
Eligible Compensation for Making Annual Solo 401k Contributions
Generally, the term “earned income” is defined to mean the individual’s net earnings from self-employment activities in a trade or business. (IRC 402(a)). In addition, the earned income must arise from the individual’s personal services and the personal services must be a material income-producing factor. (IRC. 401(c)(2)(A)(I); Reg. §1.401-10(c)(1). Income from the disposition of certain types of property is also deemed earned income. The purpose of the earned income rules from self-employment is to provide a solo 401k plan for the self-employed so that they can save for retirement, and to exclude inactive owners whose income is derived only from investments as investment income is not considered “earned income.”
Earned Income for Qualifying for a Solo 401k Plan
The IRS forms or schedules that are used to determine if you are self-employed and/or have net business income vary by entity type. The following tax documents can help you determine if you are generating earned income from self-employment activity to qualify to open a solo 401k plan, or to determine if you qualify to make contributions to your existing solo 401k plan for the year.
- If the entity type is a Sole Proprietor, the starting figure for calculating the annual solo 401k contribution is line 31 of Schedule C.
- If the entity type is a C-Corporation, the starting figure for calculating the annual solo 401k contribution is W-2 income.
- If the entity type is an S-Corporation, the starting figure for calculating the annual solo 401k contribution is W-2 income.
- If the entity type is a Partnership, the starting figure for calculating the annual solo 401k contribution is Schedule K of Form 1065 line 14.