In memorandum 201935011 the IRS provides general legal advice on the determination of whether a contribution by an employer to the employer’s qualified retirement plan (note that a solo 401k plan falls under the qualified plan umbrella and allows for employer contributions) has actually been paid to the plan’s trust such that the contribution is deductible under § 404(a) of the Internal Revenue Code (“Code”) for the employer’s taxable year in which the contribution is made (assuming all other applicable requirements are satisfied). This determination is made under the standards set forth in Don E. Williams Co. v. Commissioner, 429 U.S. 569 (1977), which applies an objective outlay-of-assets test.
This memorandum describes the elements of this test, provides that the application of the test is made taking into account the relevant facts and circumstances of the contribution, and includes illustrative examples.

ISSUE

For purposes of § 404(a), how is a determination made that an employer’s contribution has been paid within the meaning of § 404(a) to the trust of a qualified retirement plan in a taxable year of the employer maintaining the plan for which the employer claims a deduction?

CONCLUSION

For a contribution by an employer to the trust of a qualified retirement plan maintained by the employer to be deductible under § 404(a) for the employer’s taxable year in which the contribution is made, the contribution must be a payment of cash (or its equivalent) or property to the trust.

Section 404(a)

Section 404(a) governs the deductibility of a contribution to the trust of a deferred compensation plan maintained by an employer for its employees that satisfies the qualification requirements of § 401(a). Pursuant to § 404(a)(6), if an employer makes a payment no later than the due date (including extensions) for filing the employer’s return for a taxable year, and if the payment is on account of that taxable year, then the employer is deemed to have made a payment on the last day of the preceding taxable year.

Often called DC plans, DC stands for “defined contribution” plan.

The Most Popular Types of Defined Contributions Plans

The most popular DC plans allow for both employee and employer contributions.  The most popular types of DC plans are 401k plans (note that a solo 401k falls under the defined contribution type too but it is a plan only for the self-employed) 403b plans, Thrift savings plans (TSPs) and 457b plans.

• 401(k) plans are for employees of private sector companies.
• Thrift savings plans (TSPs) are similar to 401(k) plans and are for employees of the federal government and for the military.
• 403(b) plans (also known as tax-sheltered annuity or TSA plans) are for employees of public schools, tax-exempt employers (e.g., hospitals) and churches.
• 457(b) plans (also known as deferred compensation plans) are for employees of state and local governments. 457(b) plans are also available for certain management employees of tax-exempt employers.

Individual accounts. One of the main characteristic of a defined contribution plan is that while all participants participate in the same plan, each participant has a separate holding account known as  an “individual account.” Employee contributions and employer contributions, along with investment earnings, are allocated to each separate individual account. While most defined contribution plan sponsors only allow for investment options such as mutual funds,  a solo 401k plan can generally be self-directed into alternative investments such as real estate, notes, tax liens, private equity, crypt currency and metals, as well as equities.

The Bureau of Labor Statistics released a report this September stating 77 percent of private industry workers who had access to employer-provided retirement benefits chose to participate in those benefits. This measure is known as the take-up rate. Retirement benefits include defined benefit and defined contribution plans, with solo 401k pans falling under the defined contribution umbrella.

Among the major occupational groups, the take-up rates for retirement benefits among private industry workers ranged from 58 percent for service occupations to 86 percent for management, professional, and related occupations. Take-up rates were higher for workers in larger establishments (88 percent in those with 500 or more workers) than for workers in smaller establishments (71 percent in those with 1 to 99 workers). Among full-time workers, the take-up rate was 80 percent, compared with 57 percent for part-time workers.

Breakdown Percentages of Private Industry Workers Who Had  Access to & Took Advantage of Saving for Retirement

The number of part-time workers sticks out because many are often self-employed and are not aware that they can participate in a solo 401k plan even if they are also working for a full-time employer. CLICK HERE to learn more about participating in a solo 401k plan even if you are self-employed on a part-time basis.

The SEC Best Interest Rule which is scheduled to take effect on June 30, 2020 is under challenge by seven states (New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon) and the District of Columbia.  On September 9, 2018, these states filed a lawsuit in the U.S. District Court for the Southern District of New York essentially trying to  void the SEC Best Interest rule.  The plaintiffs argue that broker dealers are treated more favorably then investment advisers, and that the rule misleads consumers in thinking that broker-dealers are held to the same stringent rules as investment advisers.

They also claim that the rule makes it easier for brokers to market themselves as “trusted advisers” while still being able to give conflicted advice, and that the SEC contradicted “Congress’s express direction” under the Dodd-Frank Wall Street Reform and Consumer Protection Act to harmonize the standard of conduct between brokers and RIAs.

Here Are Some of the Current Reg. BI Provisions

• Reg. BI now defines “account recommendations” to include recommendations to move assets between different types of accounts or to roll over an employer plan distribution (e.g., former empl0yer 41k plan, PSP, DBP, solo 401k, etc.) to an IRA.
• Broker-dealers must disclose whether they will provide account-monitoring services—and the scope of those services.
• Broker-dealers must adopt policies and procedures designed to “eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.”

• Investment cost considerations are now explicitly required both in a broker-dealer’s Care Obligation and in the Disclosure Obligation.

• Broker-dealers must create and enforce policies and procedures that are designed to achieve compliance with all of Reg. BI.

To read more about the SEC Best Interest Rule, VISIT HERE.

The 401(k) regulations allow for contributions to multiple 401(k) plans. This is especially advantageous for those who have a full-time job and participate in that employer’s 401(k), and those who also have a self-employed business and participate in that self-employed business solo 401(k).

A solo 401(k) is made up of employee and employer contributions.

The employee contribution which for 2019 is $19,000 plus $6,000 for those age 50 or older is aggregated among all 401(k) plans.

However the profit-sharing contribution (employer contribution) is not subject to this aggregation rule.

As a result, if you have a solo 401(k) plan for your self-employed business and have already contributed the $19,000 plus $6,000 to the full-time employer 401k plan, you can still contribute the profit-sharing portion to the solo 401(k) plan even though you have already contributed the maximum of $62,000 (includes the catch up amount and employer profit sharing contribution)  to the daytime job 401k plan.

For example, let’s assume that your self-employed business is an S corporation and that you want to make a contribution to the solo 401(k). Let’s further assume that you have $100,000 of W-2 income from your S corporation.

Example & The Voluntary After-Tax Solo 401k Exception

Therefore, you would be able to contribute  a profit-sharing contribution (employer) amount of $25,000 into the solo 401(k) which was calculated by multiplying 100,000 × 25%. The end result, means that you would have contributed a total of $87,000 ($62,000 plus  $25,000) in aggregate to both your daytime job employer 401(k) and your self-employed business solo 401(k) plan. However, if you also want to make voluntary after-tax contributions , you could contribute the difference up to the $56,000 ceiling to your voluntary after-tax solo 401k account since this contribution type is not subject to the aggregation rules described above. VISIT HERE to learn more about this exception.

QUESTION:

I am thinking about doing an in plan Roth 401k conversion of the remaining funds in the pre-tax part of my solo 401k plan (around $300K). I am with my tax advisor now and we are questioning if this could be recharacterized (undone) later in 2019 when my tax situation becomes clearer.

ANSWER:

That is a great question and the short answer is no. 401k funds including solo 401k funds that have been converted to a Roth 401k status (known as an in-plan conversion) cannot be recharacterized to pretax 401k funds once converted. If you wish to proceed with the in-plan Roth solo 401k conversion, your solo 401k provider will need to document and report the in-plan Roth solo 401k conversion to the IRS using Form 1099-R.

More Roth Solo 401k in-plan conversion tips

Tip 1: Roth 401k conversions are reported on form 1099R using code “G” not codes 2 or 7 which are the codes used to report Roth IRA conversions.

Tip 2: When converting pretax solo 401k assets such as physical real-estate to a Roth solo 401k, the property must be appraised by a third-party valuation provider to ensure the correct value being converted is reported on form 1099-R.

Tip 3: Once converted the Roth Solo 401k funds can later be transferred to a Roth IRA which is a good planning option because Roth solo 401k plans are subject to required minimum distributions (RMDs), but Roth IRAs are not.

Tip 4: The Roth Solo 401k conversion rules allow for the conversion of after-tax funds provided the solo 401k provider’s plan documents allow for it.

QUESTION:

My intent is to co-invest with my 401k in newly formed LLC, to be capitalized 24% by 401k and 76% by me. This is to enable funding of land and the design and build of building for purposes of lease to third parties and income generation. Can you explain any particular requirements for such scenario?

ANSWER:

To confirm, it will need to be a newly formed LLC which means units have not previously been issued. This is very important as it may be a prohibited transaction if the solo 401k owner also invests personal money in an existing LLC that had previously been funded with his or her solo 401k funds.

Following are some more important requirements:

• Each member’s interest must be listed on the LLC operating agreement (in this case, the solo 401k and solo 401k owner’s interest);

• The LLC operating agreement must include language pertaining to the 401(k) and IRS regulations;

• The LLC cannot incorporate non-recourse financing or recourse financing because the solo 401k owner also invested in the LLC;

• If the solo 401kowner is the manager of the LLC, he or she cannot receive any compensation;

• The solo 401k owner can not perform any sweat equity work on properties owned by the LLC;

• The bank account will need to be opened in the name of the LLC;

• All income and expenses must flow through the LLC bank account; and

• From a  solo 401k distribution planning perspective, once the solo 401k owner starts taking distributions from the Solo 401(k), the income has to flow from the LLC bank account to the 401(k) first and then the solo 401k owner can process distributions from the solo 401(k).