BACKGROUND:
I was told by other Solo 401k providers
that the IRS frowns upon S-corporations that don’t receive earned income but
instead passive income. As I mentioned...I have no passive income but I was
told by other Solo 401k providers that I can receive $22k management fee for
the properties and that would be considered self-employment income; thus, I
could open Solo 401k.
ANALYSIS & RESPONSE: While all business entity types, e.g., LLC,
Sole Proprietorship, C-Corp. and S-Corp., for example, can generate
self-employment income, in order to open Solo 401k and make annual contributions, the self-employment income must result
from the self-employed individual’s personal services. As a result, passive
income generally does not count towards compensation for Solo 401k qualifying
or contribution purposes.
Direct form the horse’s mouth—here’s what page 15 of
IRS Publication 560 has to say about self-employment income:
“Self-employed individual. You can make contributions on behalf of yourself
only if you have net earnings (compensation) from self-employment in the trade
or business for which the plan was set up. Your net earnings must be from
personal services, not from investments.”
Here’s the link to IRS Publication 560: Retirement
Plans for Small Business:
ANALYSIS CONTINUED: Therefore, if you are generating self-employment
income through your S-Corporation, which sounds like is involved in the real
estate field, you may qualify for Solo 401k. However, make sure that you are performing services that led/lead to
the self-employment income as detailed above and not from investments. In other
words, if you are just sitting back and receiving passive income from real
estate (collecting rents), but you are not performing services, e.g., fixing
the properties, managing them, etc., you are truly not self-employed. What’s more, make sure you are filing Form
1120S: U.S. Income Tax Return for an S Corporation to report self-employment
income as this is the number one mechanism the IRS uses towards determining if
one has self-employment income and thus qualifies for Solo 401k. Lastly, we strongly recommend that you work in
concert with your personal accountant to confirm if your S-Corporation is
generating passive vs. compensation before proceeding to open Solo 401k.
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