Codes Used in Box 7 of Form 1099-R for Reporting Solo 401k Distributions & Conversions

Whether you take a distribution from your solo 401k, process conversions (e.g., mega backdoor) or a direct rollover to an IRA, box 7 of Form 1099-R is used to report whether such transaction(s) is taxable or not. Please also VISIT HERE for a distribution crib sheet.

Here are the various codes listed in box 7 of Form 1099-R. 

Code 1-Early Distribution

Use Code 1 only if the solo 401k participant was not age 59 1/2 or older at time of the distribution, AND codes 2,3, and 4 do not apply. Code 1 still applies even if the participant made the distribution to cover medical expenses, qualified higher educational expenses, a first-time home purchase, a qualified reservist or qualified birth or adoption distribution. Lastly,  if applicable, code 1 may also be used with codes 8, B, D, K, L, M, or P. 

Code 2-Early Distribution Exception

Use Code 2 if a distribution exception applies and the solo 401k participant was under age 59 1/2 at time of the distribution. Code 2 is used when the solo 401k participant takes a distribution because of the following:

  • The distribution was made to satisfy an IRS levy under section 6331.
  • The participant qualifies for a penalty tax exception that does not require using codes 1.3, or 4.

Code 3 may be used with code D. . 

Code 3-Disability

Use Code 3 if the solo 401k distribution was made on account of disability pursuant to Section 72(m)(7). Code 3 may be used with code D.

Code 4-Death

Use Code 4 regardless of the solo 401k participant’s age to report payments made to the decedent’s beneficiary. Code 4 may be used with code 8, B, D, G, H, K, L, M, or P.

Code 5-Prohibited Transaction

Use Code 5 if there was a prohibited transaction involving the solo 401k. No other codes are used with code 5.

Code 7-Normal Distribution

Use Code 7 if the solo 401k participant was age 59 1/2 or older at time of the distribution. Code 7 may be used in combination with codes A, B, D, K, L, or M.

Code B-Roth Solo 401k Distribution

Use Code B to report a distribution from a Roth Solo 401k; however, if the Roth solo 401k was directly rolled over to a Roth IRA used code H instead. Code B may be used with codes 1, 2, 4, 7, 8, G, L, M, P, or U. 

Code G-Direct Rollover & Direct Payment

  • Use Code G for a direct rollover from a pretax solo 401k plan to another qualified plan or to a Traditional, SEP or SIMPLE IRA, but not a Roth IRA.
  • Code G is also used to report non-taxable direct rollovers from an IRA to a solo 401k plan.
  • IMPORTANT: Use code H for a direct rollover of a Roth solo 401k to a Roth IRA. DO NOT use code G.
  • Use code G for in-plan solo 401k conversions including the conversion of voluntary after-tax solo 401k funds (mega backdoor) to a Roth solo 401k or to a Roth IRA.
  • Lastly, Code G may be used with codes 4, B, or K. 

Code H-Direct Rollover of a Roth Solo 401k to a Roth IRA

Use Code H is used to report the direct-rollover of a Roth Solo 401k to a Roth IRA. Code H may be used in combination with code 4. 

Code L-Solo 41k Participant Loan Treated as Deemed Distribution Under section 72(p)

Do not use code L, Loans treated as deemed distributions under section 72(p), to report a plan loan offset. See “Loans Treated as Distributions” in the 2020 Instructions for Forms 1099-R and 5498. 

Code L may be used with codes 1, 2, 4, 7, or B. 

Form 1099-NEC For Self-Employment Income for Opening a Self-Directed Solo 401k and Making Contributions

For tax year 2020 and future years, compensation paid to independent contractors will need to be reported on Form 1099-NEC.  For prior years Form 1099-R MISC was used to report compensation paid to independent contractors.

This new Form 1099-NEC  requirement will indirectly impact existing solo 401k participants and those planning to open a solo 401k plan in that they will now base their solo 401k self-employment income eligibility requirement on the new form instead of Form 1099-MISC.

By way of background, in order to participate in a solo 401k the individual must be self-employed  through a formal entity such as an S-corporation, LLC, Partnership, etc., or as an independent contractor.

Payroll Company and Voluntary After-Tax Self-Directed 401k Contributions (A.K.A. Mega Backdoor Solo 401k)

BACKGROUND & QUESTIONS

I need guidance on some of the mechanics of getting things moving money into and within my new self-directed 401k.  Specifically:

  1. I have signed up with ADP after checking out other payroll companies.  It seems that no one understands voluntary after tax contributions to a solo 401k.  Their options are regular 401k (pretax) and Roth 401k.  I cannot imagine I am the first customer to have this issue.
    1. Any guidance on how to set up this kind of contribution in payroll?  I just want to make sure they go into the right places on the W2 for tax purposes.
    2. Is there a common workaround that people use?

ANSWERS:

Ultimately, it is simple as telling the payroll company to send the voluntary after-tax contribution to the specific voluntary after-tax subaccount of the self-directed 401k. Since this voluntary after-tax contributions will not need to be reported on the W-2 (it’s optional report voluntary after-tax contributions), the payroll company does not need to track it for W-2 reporting purposes. If the payroll company cannot accommodate this, you can simply send the money directly to the voluntary after-tax subaccount.

Mechanics of Making Contributions based on W-2

First, it is clear that both the employee and employer contributions don’t need to be made until the business tax return deadline including any timely filed extensions (e.g. see the chart on page 3 of IRS Publication 560).

Second, if you want to report the employee contributions on your w-2 you can take the following steps: (i) tell the payroll company what you will contribute so that payroll company can report on w-2 (e.g.,  per the w-2 instructions pre-tax elective deferrals are not included in Box 1 of the w-2 and are listed in Box 12 and the “Retirement Plan” field is checked in Box 13) & (ii) “park” the money (e.g. in personal acct) and then make sure that you open solo 401k bank or brokerage account & deposit the contributions by the business tax return deadline including any timely filed extension.

CONSIDERATIONS REGARDING MAKING VOLUNTARY AFTER-TAX CONTRIBUTIONS:
  • Our plan allows you to make voluntary after-tax contributions.
  • Please see below information regarding limits and mechanics of making contributions.
  • Please also see the following link: §  Mega Back Door Roth
  • Please let us know when you make voluntary after-tax contributions and convert to the Roth 401k sub-account so that we capture the information needed for 1099-R reporting.
How Much Can I Contribute to my After-Tax Sub-account for 2020?
 
Generally speaking, the amount of 2020 after-tax contributions that can be made to the Solo 401k is determined as follows:
  • 2020 After-Tax Contribution Limit: Lesser of (1) 100% of compensation or (2) the overall limit that applies the year for which the contribution is made (e.g. $57K for 2020))  LESS any other Solo 401k contributions (e.g. elective deferrals (either roth or pre-tax) OR profit sharing)
  • If the entity type is a Sole Proprietor (or a single-member LLC taxed as disregarded entity), self-employment compensation is equal to line 31 of Schedule C LESS deducting one-half of self-employment tax.
  •   If the entity type is an SCorporation, it is equal to W-2 income from your self-employed business (“Box 1 plus any pre-tax elective deferrals NOT in Box 1).

How do I make the voluntary after-tax contributions?

  • To make the contribution, you will make the check payable in the name of the solo 401k and write “Annual Contribution” on the memo section of the check.
  • Deposit the amount of the voluntary after-tax contributions that you elect to make in the separate voluntary after-tax sub-account.
  • You will then transfer the funds to the Roth sub-account for the Solo 401k(or Roth IRA).  Please let us know right away when you do so that we can send you the applicable forms to capture the information that we need to handle the required 1099-r (which we will do as part of our services for no additional charge).

Where do I report the voluntary after-tax contributions?

  • For self-employment income reported on a w-2, you may (but are not required to) report voluntary after-tax contributions in Box 14 of the w-2.
  • For all others, there is no place to report voluntary after-tax contributions.

Where do I report the conversion of funds form the voluntary after-tax subaccount to the Roth sub-account?

  • A Form 1099-R is used to report the conversion to the IRS.
  • On Form 1040, report the amount converted in Line 4a and “0” in Line 4b unless there is a taxable gain.  Enter the word “Rollover” next to line 4b.
  • A taxable gain would result if the funds in the after-tax account accrued a gain after being contributed to such account in which case the amount of such gain is a taxable and needs to be listed on Line 16b.

Backdoor Self-Directed 401k Conversion Form and Frequency QUESTION:

I am likely to convert any voluntary after-tax contributions to Roth.  Am I able to that multiple times during the year or just once?

You may convert after-tax contributions to a Roth solo 401k subaccount (or Roth IRA account) more than once per year. When you are ready to process  the conversion,  you can fill out the following on-line conversion forms so that we can  capture the information that will be needed to report the rollover on a 1099R.  For the sake of good record-keeping, you will want to complete the form each time you do a conversion.

After-Tax to Roth IRA Conversion Form

After-Tax to Roth Solo 401k Conversion Form

Solo 401k for Working Spouses

A solo 401k is for the working business owners and their spouses.  However, if the business that sponsors the solo 41k employs non-owner W-2 employees who meet the following eligibility requirements, neither the owners of the business nor their spouses will be eligible to open or to continue with the solo 401k plan.

If the business employees non-owner W-2 employees who work 1,000 hours or more, the business cannot sponsor a solo 401k plan.  What is more, if the business is currently sponsoring a solo 401k plan and one of the non-owner W-2 employees works 1,000 hours during the year, the solo 401k plan will need to be converted/restated to a full-time employer 401k plan and also offered to the now eligible full-time employee.

Starting in 2021, once the business sponsoring the solo 401k plan employs a part-time, non-owner W-2 employee (defined as 500 but less than 999 hours)  who works part-time for 3 consecutive years, the solo 401k plan will need to be converted to a full-time employer 401k plan.

S-Corp Both Spouses Contribution QUESTION:

The Mega Roth might work very well for one of my clients. He is Sheriff and has a real estate S-Corp. business on the side with no employees and wants to maximize the ROTH for him and his wife. Would his wife need to be an employee to get the $57K limit for both?

Both he and his wife can participate in the solo 401k they’re both working in the business and receive W-2 wages from the business. Each of them will be able to contribute to the plan based on their respective W-2 wages that they each receive from the business (along with other factors such as their age and whether they make contributions to another 401(k) plan such as through a “day job”).

How to Add My Spouse to the Solo 401k Plan QUESTION:

I have a solo 401k through you. I am curious how to add my spouse to my plan, so I can provide her the ability to contribute to my solo 401k?

First, if she is not yet listed on the solo 401k plan, we first need to list her on the plan documents.  Second, as long as she is also working in the self-employed business that the solo 401k plan was set up for (a.k.a. the plan sponsor), she will also be eligible to make contributions to the solo 401k plan based on earned income she receives from the business. Third, she will need to open a separate participant account (brokerage or bank account) to hold her solo 401k funds under the plan. She may also need multiple holding accounts if she plans to contribute multiple sources of funds (e.g., Roth, pretax and voluntary after-tax) to the solo 401k plan. Please provide her legal name when you are ready to have us add her to the plan.

Domestic Partner Spouse QUESTION:

My 2nd employee (in addition to myself) is my domestic partner (DP; unmarried). Please confirm the spousal exclusions for 401k plan participation also applies to DPs. With the 1000 hr rule I felt I was covered assuming any challenge re DP status. Now that the rule for participation is 500 hours I'm unsure and need clarification. To be clear, she is not currently participating in the 401k?

Yes Domestic Partners are treated as spouses (see Section F(10)(c)(iii)).

Consolidated Appropriations Act (CAA), 2021 Does Not Extend COVID-19 Solo 401k Distributions or Solo 401k Participant Loan Payments

The Consolidated Appropriations Act, 2021 (CAA) bill was passed on December 21, 2020 and signed into law by the President on December 27, 2020.  While the bill provides limited additional coronavirus (COVID-19) pandemic relief and some disaster relief, the bill did not extend the December 30, 2020 deadline to take the $100,000 maximum distribution from IRAs and 401k plans including owner-only solo 401k plans.

Disaster Relief  for Damage Resulting from Wild Fires and Hurricanes

CAA only extends relief if you lived in a regional qualified disaster zone that was impacted by wildfires and hurricanes, for example, but it excludes disasters that are declared solely in response to the COVID-19 pandemic.

For Taking the Solo 401k Distribution or Participant Loan a “qualified individual” is defined as:

  1. Whose principal place of abode is located in a qualified disaster area; and
  2. Who suffered an economic loss as a result of the qualified disaster.

Distributions

If you qualify for the above qualified disaster distribution (QDD) relief (hurricane and wildfires), the following applies to distributions from IRAs and solo 401k plans:

  • Individuals can distribute up to $100,000  without penalty or withholding for disasters that begin on or after December 28, 2019, and that end on or before December 27, 2020 (the date the CAA was signed into law).
  • The disaster distribution must be taken within 180 days of December 27, 2020. If an individual is affected by multiple disasters, this dollar limit applies separately to each disaster.
  • The distribution is taxed ratably over a 3-year period and may be recontributed in 3 years and will be treated as  direct rollovers when returned to the 401k or IRA.

Loans

  • Solo 401k participant loans may be taken for up to $100,000 or the participant’s vested account balance, whichever is less.
  • The solo 401k participant loan may be taken within 180 days after December 27, 2020.
  • For outstanding solo 401k loans, repayments may generally be delayed for a year (or if later, 180 days after December 27, 2020). The additional time to pay the outstanding loan applies to loan repayments that are due within the period beginning on the first day of the disaster and ending 180 days following December 27, 2020.

CAA Did NOT Waive Required Minimum Distributions (RMDs) from IRAs or Solo 401k Plans, so Are Required in 2021

While RMDs from solo 401k plans and IRAs were waived in 2020,  the new COVID-19 stimulus law (CAA) did NOT extend the RMD waiver. While the 2020 RMD will not need to be taken or made up in 2021, the 2021 RMD will apply and it will be based on the fair market value (FMV) of the solo 401k plan as of 12/31/2020.

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