IRS Puts Qualified Plans (solo 401k) and IRAs on Its 2019 Priority List

On April 5, 2019, the IRS  released the 2018-2019 fiscal year Priority Guidance Plan (PGP).

The items on this list are similar to a wish list that the IRS plans in addressing each year, and some carry over from prior years.

Here are some of the items listed in this years guidance as they relate to solo 401k plans, IRAs and ROBS 401k plans.

  • Regulations under Internal Revenue Code Section (IRC Sec.) 401(a)(9) updating life expectancy and distribution period tables for purposes of the required minimum distribution (RMD) rules
  • Guidance on hardship distributions from employer-sponsored retirement plans (in response to the Balanced Budget Act of 2018 provisions)
  • Guidance on missing retirement plan participants
  • Guidance on Traditional and Roth IRAs, Including contributions and excise taxes
  • Affiliated service group guidance
  • Additional guidance on lifetime income payments from employer plans and I

 

 

 

April 2019 IRS Release FAQs for Code Section 199A QBI Deduction

In April of 2019 the IRS released its much anticipated FAQs surrounding qualified business income (QBI) deduction. While somewhat delayed in publishing these FAQs, (the deduction was created by the 2017 Tax Cuts and Jobs Act, under Internal Revenue Code Section 199A) better late than really late.

This piece of legislation is important for solo 401k plan participants because In Q32 the IRS specifically addresses how the deductible contributions that the self-employed individual makes to a qualified retirement plan (a solo 401k plan falls under this umbrella) are accounted for when determining QBI.

Primary Residence Solo 401k Participant Loan Question

 QUESTION:

Can I take a participant loan from my solo 401k plan for  15-year or 30-year  term  if I use the funds for the purchase of my primary residence even though there will be no mortgage or bank loan on the property.  The reason there is no loan is that either a) the house is purchased all cash using the 401k loan funds or b) the seller is caring the note for the home purchase.

ANSWER:

The Code does not state that in order for the solo 401k participant loan to qualify under the primary residence loan term  payment exception  where the 401k plan loan can be paid over a period longer than 5 years a mortgage is required.  Therefore, understanding in the industry is that as long as the 401k loan is for the purchase of a primary residence, the repayment term could be either 15-year or 30-year repayment term (based on the general loan terms in your local area). IRC Section 72(p)(2)(B)(ii) says that 5-year max does not apply to principal residence loans (but does not provide a higher max).  Lastly, the solo 401k plan documents would also need to include language allowing for the 15 or 30 year 401k participant loan term payment period.

Retirement Enhancement and Savings Act (RESA) Has a Good Chance of Passing in 2019

Earlier this month, the Retirement Enhancement and Savings Act (RESA) was reintroduced by by Senate Finance Committee Chairman Charles Grassley (R-IA) and Ranking Member Ron Wyden (D-OR). Both the Senate and the House appear to be onboard with the bill so it has a darn good chance of passing in 2019.

Here are some of the provisions outlined in the bill:

Allow more time to establish a plan: Permit qualified plans (e.g.,  solo 401k, profit sharing or pension plans) to be established as late as the sponsoring employer’s tax return deadline, including extensions. (effective for 2020 and later taxable years).

Raise plan start-up credit for small employers: The plan start-up credit for small plans would raise from $500 to a maximum of $5,000 per year, available for three years beginning with the year the plan is established (effective for 2020 and later taxable years).

Plan reporting failures would be more costly: Retirement plan information reporting failures would result in the following penalties (effective for returns, statements, and notices required January 1, 2020, and thereafter).

  • Form 5500 and Form 5500-EZ, $100 per day, up to a maximum of $50,000

Require quicker payout to beneficiaries: With limited exceptions, most nonspouse beneficiaries of IRAs, qualified defined contribution including from solo 401k plans, 403(b), and governmental 457(b) plans would be required to distribute inherited amounts within five years. New reporting requirements to ensure compliance would apply (effective for plan participant/IRA owner deaths occurring in 2020 or later, and to beneficiary reporting beginning with the 2021 calendar year).

Exceptions include the following.

  • Aggregate inherited IRA and employer plan balances that do not exceed $400,000
  • Disabled
  • Chronically ill
  • Beneficiaries not more than 10 years younger than the deceased participant or IRA owner
  • Minors (a five-year payout period would begin upon reaching the age of majority)

Allow for Traditional IRA contributions past age 70 1/2: Similar to Roth IRA owners, Traditional IRA owners with earned income could make IRA contributions at any age, not just before age 70½ (effective for 2020 and later taxable years).

Allow graduate student IRA contributions: Certain fellowship, stipend, and similar payments to graduate students and postdoctoral students would be treated as earned income for IRA contribution purposes (effective for 2020 and later taxable years).

Permit IRAs and S Corporation bank shares: IRAs would be permitted to hold shares of S Corporation banking entities (effective January 1, 2020).

Does the 10% Early Distribution Pentaly Apply to QDRO Divorce Payments from Solo 401k Plans?

QUESTION:

My husband an I recently divorced. As is typical, half of my solo 401k got awarded to him pursuant to a qualified domestic relations order (QDRO). If he elects to take his portion from the solo 401k as a distribution instead of rolling it over to an IRA or another 401k plan, will he have to pay the 10% early distribution penalty since he is under age 59 1/2?

BACKGROUND:

A QDRO is a judgment, decree, or order relating to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant in a retirement plan including a solo 401k plan.

The QDRO must contain certain spe-cific information, such as the name and last known mailing address of the participant and each alternate payee, and the amount or percentage of the participant’s benefits to be paid to each alternate payee. A QDRO may not award an amount or form of benefit that isn’t available under the solo 401k plan.

A spouse or former spouse who receives part of the benefits from a retirement plan including a solo 401k plan under a QDRO reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant’s cost (investment in the contract) equal to the cost times a fraction. The numerator of the fraction is the present value of the benefits payable to the spouse or for-mer spouse. The denominator is the present value of all benefits payable to the participant.

A distribution that is paid to a child or other dependent under a QDRO is taxed to the plan participant.

ANSWER:

Taxes and penalties does not apply to QDRO funds that are transferred to another 401k plan or directly rolled over to an IRA. In the case where the alternate payee is the former spouse and he or she elects to take a distribution, unlike IRAs, no the 10% early distribution penalty does not apply from a qualified retirement plan such as a solo 401k plan to an alternate payee under a qualified domestic relations order. This rule is outlined in IRS Publication 575.

 

IRA LLC / Checkbook IRA Required Beginning Date Top Items

The required beginning date (RBD) applies to IRA participants and IRA beneficiaries, and is significant because it results in having to take distributions from the IRA. Following are some important items to know about the RBD.

1. The RBD for IRA LLC owners is the date that required minimum distributions (RMD) must commence.

2. The RBD for IRA LLC owners is April 1 of the year after the year the IRA owner reaches age 70 1/2.

3. The first year of for which the RMDs must begin (distributions for the age 70 1/2) is the only year the IRA LLC owner can wait until the following April 1 to take the distribution.  For subsequent years, RMDS must be taken by December 31.

4. If the IRA LLC owner delays the firs RMD until the following year to distribute the first-year RMD, she must also take the second-year RMD by December 31 of the same year.

For example, when Cindy turns 70 1/2 on May 19, 2019, she can either take the her first RMD by December 31, 2019 or she can delay her first RMD and take it by April 1, 2020. If Cindy decides to take her first RMD by April 2020, she will also need to take her 2020 RMD by December 31, 2020.

5. If an IRA LLC owner dies before their RBD, there is no RMD due for the year of death, even if the IRA LLC owner was age 70 ½ at the time of their death.

6. If the IRA LLC owner dies after their RBD, the  RMD  due for that year must be distributed by the IRA beneficiary if the IRA owner did not make it prior to her death.

7. For IRA LLC owners who deceased prior to their RBD, the IRA beneficiary can elect to take required distributions over her life expectancy or by the end of the 5th year.

8. For IRA LLC owners who deceased on after their RBD, the IRA beneficiary can not delay distributions until the end of the 5th year.

9. If the IRA LLC owner dies on or after their RBD, the beneficiary can use the age of the IRA holders death or her age to to base the RMDs.

10. If the IRA LLC owner also participates in a solo 401k plan, the RMDs due from the IRA LLC must be distributed from the IRA LLC not the solo 401k plan.

11. Roth IRA LLCs are not subject to RMDs.

 

Solo 401k/IRA Money to Exercise Stock Options

BACKGROUND:

I have recently left a job and need to exercise stock options by June 12th.  My husband and I would like to combine the $ from my 401k ($79k) with $ from his rollover IRA ($46k) and use the combined amount to exercise the stock options.  From what I understand so far, a solo 401k or a self-directed IRA LLC may be a mechanism for doing this.

ANSWER:

Both the solo 401k and the IRA regulations do not allow for the use of retirement funds to invest in stock options for your employer or stock options that you already own and would like to exercise. Doing so would result in a prohibited transaction subjecting the IRA or the solo 401k plan to disqualification and taxes.

To learn more about the prohibited transaction rules, please see the following. https://www.mysolo401k.net/solo-401k/prohibited-transactions-solo-401k/

The prohibited transaction rules are found both in the Internal Revenue Code (IRC) and in ERISA.

  • Click here to learn about prohibited transactions under ERISA.
  • To learn about prohibited transactions under Internal Revenue Code click here.

 

 

Do I have Make Pretax Solo 401k Contributions If I Make Roth or Voluntary After Tax Contributions

BACKGROUND:

I recently found your website and would like to compliment you on the wealth of information that you share there. I currently have a solo 401k at a competitive company with a plan that provides for after tax contributions and in-service distributions. But I am interested in moving the plan to your firm as the plan provider in 2019. As I study my options for the future, I wondered if you could please clarify one point for me.  Assuming that a person is self-employed with $100k+ of net self-employed income, if that person makes a maximum Roth 401(k) salary deferral contribution ($19,000 for 2019), is it necessary (or advisable) to also make some sort of tax-deductible 401(k) profit sharing contributions (up to 20% of net SE income) before taking advantage of the After Tax contribution component and the subsequent backdoor roll to a Roth IRA?  Or can the person just skip the tax-deductible profit sharing contribution, and go straight to maxing out the 415 limit ($56,000 for 2019)?  In other words, can this person make a $19,000 Roth Solo 401k deferral and then make a $37,000 After Tax Contribution, which is then immediately rolled into a Roth IRA?  Would doing this raise any red flags with regulators or be frowned upon?  Does it “look” better to make some sort of tax-deductible profit sharing contribution?

Thanks in advance for your advice.  I hope to be able to do business with your company in the near future!

ANSWER:

There is no requirement to make a profit sharing contribution and doing what you describe is acceptable, as the solo 401k regulations do not require the participant to make one type of contribution in order to make a different type. However, the solo 401k participant can not make annual contributions of any type (i.e., pretax, voluntary after-tax or roth) in years with no self-employment income from the business that sponsors/adopted the solo 401k plan.

To get started, please submit our online app: https://www.mysolo401k.net/solo-401k/open-a-solo-401k-account/

Consider a Donor-Advised Fund When Converting Pretax Solo 401k to a Roth Solo 401k To Ease the Tax Hit on the Conversion

The conversion of pretax solo 401k funds to a Roth solo 401k results in income taxes due on the converted amount. In exchange, the money in the Roth solo 401k grows tax free, and the Roth solo 401k owner and her heirs can also take tax free distributions once distribution triggering events are satisfied.

A possible way to mitigate the tax hit on the Roth solo 401k conversion is to spread the in-plan conversion over a few years (i.e., convert small amounts each year). If the right amount is converted, it may also prevent the income from conversion tipping you into a higher tax bracket.

Another way to help stem the resulting tax hit from the conversion of pretax solo 401k funds to a Roth solo 4o1k is to consider a donor-advised fund, or DAF. DAFs are programs offered by public charities and allow charitable contributions to be made in a given year; however, the donor (the solo 401k participant) can make a tax deduction for that year. Then, at any time, grants can be recommended from the DAF to the charities the donor wants to support. A tax deduction taken in the year of the Roth solo 401k conversion can help offset the in-plan solo 401k conversion taxes.

Should I Open a Solo 401k or an IRA LLC for Investing in Real Estate?

SCENARIO:

My husband has recently transitioned employers and we are considering the idea of rolling over his previous employer’s provided 401(k) into a self-directed IRA.  Our primary interest is using these funds to invest in real estate.  From the details provided online, we are mainly interested in the Solo 401(k) or the IRA LLC. The only tricky part that I foresee is that part of his current investment is Roth and the other part is Traditional.  Would we be able to transfer the two funds into equivalent structures or would we need to consolidate somehow – choosing either Roth or Traditional for the full amount?

ANSWERS:

Both the IRA LLC & The Solo 401k Plan May Invest in Real Estate and Other Alternative Investment 
Both the solo 401k and the IRA LLC allow for investing in real estate. In order to participate in a solo 401k plan certain eligibility requirements apply which don’t apply to an IRA LLC. As a result, most individuals qualify for the IRA LLC, but not the solo 401k plan.
Qualifying for a Solo 401k Plan
 
In order to qualify for a solo 401k plan, you need to be performing at minimum part-time self-employment activity in order to open and continue with the Solo 401(k) plan, and it has to be active income versus passive investment income. One way to distinguish passive income versus active income is that active income is subject to Social Security taxes were as passive income is not because it’s considered capital gains income. Visit Here to learn more about the solo 401k eligibility requirements.
If Both Spouse Work for the Self-Employed Business 
Since a Solo 401k is for business owners and their spouses, the business owner’s spouse is also eligible to participate in the same Solo 401k provided he or she is also self-employed in the business.
Roth IRA Transfer Restriction
The Roth IRA rules do not allow for the transfer of a Roth IRA to a Roth 401k including a Roth solo 401k. This is an IRA regulation. For more on this rule, please see the following. https://www.mysolo401k.net/can-transfer-roth-ira-401k-solo-401k/
Don’t Confuse the Roth IRA Transfer Restriction with the Roth 401k
While the Roth IRA rules do not allow for the transfer of a Roth IRA,  the rules do allow for the transfer of a former employer Roth 401k, Roth 403b, Roth 457b and Roth TSP to a Roth solo 401k provided they are held in a separate bank or brokerage account within the solo 401k plan.
Multi Member IRA LLC
If you decided to go the IRA LLC route, both the pretax IRA and the Roth IRA can be invested in the same LLC; however, this will trigger annual required federal tax filings at the LLC level because an LLC with more than one member (e.g., a Roth IRA and a Traditional IRA) is treated as a partnership. Therefore, a Form 1065 and a schedule K-1 would need to filed on an annual basis. To learn more about the multi meber IRA LLC rules, visit the following: https://www.mysolo401k.net/single-member-ira-llc-multi-member-ira-llc/
Unlike a Solo 401k, the IRA LLC is Subject to UDFI
Similar to the UBIT, there is a another tax called the Unrelated Debt-Financed Income (UDFI) tax on IRA investment income derived from debt-financed property, proportionate to the debt on the property. HOWEVER, UDFI does not apply to solo 401k plans so this is why individuals prefer solo 401k plans over IRAs for investing in real estate where a none-recourse loan will be used to invest in real estate.
In sum, while we can assist in opening both the IRA LLC and the solo 401k plan, it is important to understand the above rules prior to proceeding.

 

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