self administered 401k

Hi, I’m self-employed and setup a self-administered 401k last year. My inquiry surrounds the use of my self-administered 401k by either a private loan or a promissory note to a family owned S corporation. Here are the details to check if the action would be in violation of any IRS related rules.

QUESTION: Would the following loan from my self-administered 401k to an S-Corporation be in violation of the 401k investment rules?  The S corporation is my in-laws, where my wife is also a 15% minority partner, and she works part time which equates to 20 hours per week. The funds will be a recurring short term loan to the company in order to invest in products and goods. My self-administered 401k will receive interest based on the usage of available funds on a monthly basis with an annualized APR.

Thanks,

PR in Florida

ANSWER: While the rules permit a self-administered 401k (more commonly referred to as a Solo 401k) to invest in an S-Corporation, whether through taking an equity position in the S-Corporation or through a promissory note,  your particular transaction would be in violation of the 401k prohibited transaction rules for the following reason:

1)     Your spouse is a disqualified party; therefore, because she is an owner and employee of the S-Corporation that would be obtaining the loan from your self-managed 401k, such transaction would be deemed a prohibited transaction. Such a transaction would be interpreted as benefiting a disqualified person (your wife) since she would be receiving a salary, whether on a part-time or full-time basis.

Note: Also, do you, or your children, parents, grandparents own an interest in the S corporation and also receive compensation?  If yes, your involvement in the S-Corporation as well as  said family members would also prohibit your self-administered 401k from investing in the S-Corporation because you all fall under the disqualified party umbrella. For a full list of disqualified parties, click here.

On other hand, if your wife was not an employee, director, officer or had similar responsibilities to those of a decision maker, the promissory note investment to the S-Corporation by your self-administered 401k would not be in violation of the rules.

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

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