QUESTION:
If I have an LLC, but treat it as a disregarded entity for tax purposes, how would I go about determining the limit for the employer contribution? Would I use the unincorporated sole proprietorship method since it’s a disregarded entity (20% of self-employment income) or because its an LLC I would use 25% of wages?
ANSWER:
If the LLC is taxed as a sole proprietorship then both the employee and the employer solo 401k contributions are based on your Schedule C line 31 figure, and the employer contribution is 20% of line 31 after 1/2 of self-employment tax has been subtracted.
Sole Proprietor Solo 401k Calculation
For self-employed persons, compensation means “earned income” based on the individual’s Schedule C to the Form 1040, as adjusted for the deduction for one half of self-employment taxes (Schedule SE). Because of that adjustment, the self-employed will use a figure of 20% of the net business income minus one-half of the self-employment taxes to be equivalent to 25% of includible compensation. Once the net profits have been calculated on the Schedule C, and the SE tax figures have been determined (or estimated in the case of advance planning), the maximum Solo 401k contribution may be determined as follows.
Step 1: Determine compensation
a. net profits – 1/2 SE tax = pre-profit sharing deduction compensation
b. pre-profit sharing deduction compensation / (divided by) 1.25= compensation
Step 2: Determine maximum profit sharing contribution
maximum profit sharing contribution = .25 x compensation
Step 3: Determine maximum salary deferral
maximum salary deferral = lesser of $20,500 (for 2022), or
compensation-maximum profit sharing contribution
Step 4: Calculate maximum Solo 401(k) contribution
maximum Solo 401(k) contribution = maximum profit sharing contribution
+ maximum salary deferral
NOTE:The maximum Solo 401(k) contribution for 2022 may not exceed $61,000 (unless your age 50 or older and therefore qualify for an additional $6,500 of catch-up contributions)
The maximum Solo 401(k) contribution for 2023 may not exceed $66,000 (unless your age 50 or older and therefore qualify for an additional $7,500 of catch-up contributions)
