How to Calculate Solo 401k plan or Individual K Required Minimum Distribution (RMD)

The annual Solo 401k required minimum distribution (RMD) is calculated by dividing the Solo 401k or Self-Directed 401k account balance by the applicable distribution period pursuant to Treas. Reg. 1.401(a)(9)-5, Q&A 1.

Solo 401k Account Balance

For Solo 401k plan or Self-Directed 401k, the account balance is the balance as of the last valuation date (typically December 31) in the calendar year immediately preceding a year for which an RMD is due. This is called the Solo 401k valuation year. This valuation amount is then adjusted by adding to the balance any contributions allocated to the Solo 401k plan balance after the valuation date, but during the valuation year. You must then subsequently subtract any distributions made in the valuation year that may have occurred after the Solo 401k plan valuation date.

Solo 401k plans are also allowed to exclude contributions for the valuation year not actually made in the valuation year in accordance with Treas. Reg. 1.401(a)(9)-5, Q&A 3(b). And if the first year's RMD is taken between January 1 and April 1 of the year following the first distribution year (the second distribution year), the final RMD regulations do not require that the first year's RMD be subtracted from the December 31 balance when determining the RMD for the second distribution year.

Applicable Solo 401k Distribution Period

During a Solo 401k plan trustee's/participant's lifetime, the RMD regulations provide that the distribution period for nearly all individuals of the same age (with one exception outlined later in this section) is determined using the Uniform Lifetime Table in Treas. Reg. 1.401(a)(9)-9, Q&A 2. The distribution period based on the Uniform Lifetime Table is equal to the joint life expectancy of an individual and a beneficiary exactly 10 years younger, regardless of whether a beneficiary is actually named. The result of using the Uniform Lifetime Table is a longer lifetime distribution period for most Solo 401k individuals and their beneficiaries, thereby reducing the amount a participant must take annually from his or her Solo 401k.

ILLUSTRATION: Bill is retired and turns 71 in 2011, the calendar year in which he turns 70 1/2  . Bill's RMD for 2011 is calculated by dividing his December 31, 2010, account balance of $175,000 by the life expectancy divisor from the Uniform Lifetime Table for a 71 year old, which is 26.5. Even though Bill has not named a beneficiary for his Solo 401k plan balance, his RMD is determined using a uniform distribution period equal to the joint life expectancy of an individual and a hypothetical beneficiary exactly 10 years younger. Bill's RMD for 2011 equals $6,603.77 ($175,000 / 26.5 = $6,603.77).

Exception to Uniform Lifetime Table: Spouse Beneficiary More Than 10 Years Younger

Under the Solo 401k or Individual K RMD regulations, an exception to applying the Uniform Lifetime Table exists if a spouse, who is more than 10 years younger than the Solo 401k plan trustee/participant, is the sole beneficiary. In this event, to determine the correct distribution amount, the Solo 401k plan trustee/participant should use the longer distribution period as determined by the actual joint life expectancy of the two individuals instead of the life expectancy divisor from the Uniform Lifetime Table pursuant to Treas. Reg. 1.401(a)(9)-5, Q&A 4(b)(1). What's more, the spouse is considered the sole designated beneficiary if he or she is the sole beneficiary at all times during the Solo 401k RMD distribution year. The Solo 401k regulations provide, however, that if there is a change in marital status during the year resulting from death or divorce, the change in beneficiary for ascertaining the distribution period takes effect in the year following the year of death or divorce in accordance with Treas. Reg. 1.401(a)(9)-5, Q&A 4(b)(2).

Solo 401k plan or Individual K and Required Minimum Distributions

Upon  reaching  age 70 1/2, you as trustee/participant must begin taking distributions from the Solo 401k plan or self-directed 401k pursuant to IRC Sec. 401(a)(9)(A).

The RMD rules were last update in Treas. Reg. 1.401(a) (9)-1 and are applicable to all qualified retirement plans including Solo 401k plans.

  

As an IRC Sec. 401(a)(9) qualification requirement, a plan, including a self-directed 401k , is required to start making  RMDs no later than the Solo 401k trustee's/participant's required beginning date. The annual Solo 401k plan RMD amount is reported on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Required Beginning Date

The RMD regulations require a Solo 401k plan trustee/participant to start taking distributions no later than his or her required beginning date (RBD) and to continue making distributions over a period not extending beyond his or her life expectancy or over his or her life expectancy and beneficiary of the Solo 401k pursuant to Treas. Reg. 1.401(a)(9)-2, Q&A1.

The RBD for a Solo 401k plan trustee/participant is April 1 of the calendar year following the calendar year in which the trustee/participant attains age 70 1/2 in accordance with Treas. Reg. 1.401(a)(9)-2, Q&A 2(a).

Dealing With Excess Nondeductible Solo 401k or Individual K Contributions

The Solo 401k plan participant typically makes her annual Solo 401k plan contribution when she completes her business’s tax return for the year. As a result, the Solo 401k participant can usually determine her IRC Sec. 404 deduction limits before making her Solo 401k contribution, thus preventing any excess
self-directed 401k or Individual K contribution headaches.

10 Percent Penalty and Form 5330: When the Solo 401k participant contributes more than the allowable deduction for a given tax year, she is typically required to pay a 10 percent penalty on the over contribution amount also known as the excess nondeductible contribution amount pursuant to (IRC Sec. 4972). As such, this penalty amount must be reported to the IRS by the Solo 401k participant since she is the owner of the business by filing IRS Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, and remit the penalty to the IRS. Please refer to IRC Sec. 404(a)(1)(E)  as it details that the amount of the otherwise deductible contribution that exceeds the limitation for any given year shall be carried forward indefinitely and applied to subsequent years.

IMPORTANT: Even though excess nondeductible Solo 401k or Individual K contributions may be returned to the Solo 401k employer under limited circumstances, the self-directed 401k employer runs the risk of incurring substantially greater penalties by taking a reversion of plan contributions. The reversion penalty is typically as high as 50 percent depending on the circumstances pursuant to (IRC Sec. 4980).

Claiming the Solo 401k Plan or Individual K Contribution Deduction

The process of claiming a tax deduction for a Solo 401k plan contribution is based on the type of entity maintaining the Solo 401k plan (e.g., corporation, partnership, or sole proprietorship).

Sole proprietors and partners deduct contributions for themselves on their individual tax returns (i.e., IRS Form 1040, etc.).

Corporations deduct all Solo 401k or self-directed 401k contributions on the corporate tax return. The chart in our immediate prior blog posting lists where various business entities claim deductions for Solo 401k or Individual K contributions. Here is the link: http://mysolo401k.net/Blog-for-MySolo401k.html?entry=where-solo-401k-plan-or

 IMPORTANT: Owners in a Subchapter S corporation can only use their W-2 income--not their pass-through income--for contribution purposes when contributing to their Solo 401k plan or Self-Directed 401k.  For more information regarding this rule see (Revenue Rulings 71-26 and 59-221).

Self-Employed Individuals

When identifying compensation for Solo 401k Plan or Individual K contribution purposes as a self-employed individual, you must first determine the your earned income or net earnings from self-employment.  As a self employed individual and depending on your type of self-employment, use one of the following forms to calculate net earnings for year of your Solo 401k contribution.

•   A partnership generates a Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., (an attachment to IRS Form 1065, U.S. Return of Partnership Income) for each individual partner reflecting the partner's net earnings for the year.

• A sole proprietor must file a Schedule C, Profit or Loss From Business, (an attachment to IRS Form 1040, U.S. Individual Income Tax Return) reflecting the net earnings from the business for the year.

• Farmers file a Schedule F, Profit or Loss From Farming, (an attachment to their IRS Form 1040) to show net income from farming.

• Limited liability companies generally elect to treat their members as sole proprietors or partners for tax purposes. In this situation, members must file the appropriate schedule, as described above.

Deducting Solo 401k or Individual K Contributions

Contributions made to your Solo 401k plan (except for after-tax contributions) are tax deductible to you as the owner of the employer pursuant to IRC Sec. 404. However, for the Solo 401k contributions to be deductible for a given tax year, you as the employer must make the Solo 401k contribution by no later than the business's tax return due date, including any extensions  as outlined in (IRC Sec. 404(a)(6)).

WHERE Solo 401k Plan or Individual K CONTRIBUTIONS ARE DEDUCTED

WHERE Solo 401k Plan CONTRIBUTIONS ARE DEDUCTED
Employer Type	Contributions for Business Owners
Sole Proprietorship	IRS Form 1040
Partnership	IRS Form 1040
Limited Liability Company (LLC)	IRS Form 1040 or 1120, depending on election
Subchapter S Corporation	IRS Form 1120S
Subchapter C Corporation	IRS Form 1120

Solo 401k Plan Prohibited Transaction Examples Continued: Investments in qualifying employer real property

The leasing of real property by the Solo 401k  to a disqualified (e.g., trustee, father, son, mother, sister) person would generally be considered a prohibited transaction. However, ERISA 407 prescribes rules that permit certain investments by the Solo 401k plan in qualifying employer real property. In addition, ERISA 408(e) exempts from the prohibited transaction rules, the sale or acquisition or lease by the Solo 401k plan of qualifying employer real property that satisfies the requirements of 407. IRC 4975(d)(13) exempts from the excise tax provisions of 4975 any transaction which is exempt because of ERISA 408(e). ERISA 408(e) requires that the transaction relate to qualifying employer real property. The percentage of assets held in qualifying employer real property is limited by ERISA 407. See ERISA 408(e)(3). To be an exempt transaction, the sale must be:

1.    For adequate consideration and

2.    no commission may be charged with respect to the transaction.

Definition of qualifying employer real property. To be qualifying employer real property:

1.    The property must be leased from the Solo 401k plan to the employer (or to an affiliate of the employer).

2.    The parcels of employer real property must be geographically dispersed, and

3.    Any improvements on the real property must be suitable for more than one use.

The primary purpose of the geographical dispersement and multi-use requirements is to minimize the investment risk to the Solo 401k plan participant. Investments in qualifying employer real property are exempt from the diversification requirements under ERISA 404.

Confusion exists. A lot of confusion exists with respect to the exception for qualifying employer real property. Many solo 401k plan trustees have made the mistake that any parcel of land owned by the employer may be acquired by the Solo 401k plan and leased back under this exception. This is simply not correct.

Geographical dispersement. The geographical dispersement requirement implies that there must be more than one parcel of land. In Zabolotny v. Commissioner, 7 F.3d 774 (8th Cir. 1993), a corporation unsuccessfully argued that its single parcel of farmland could satisfy the definition of qualifying employer real property. The court held that a single parcel does not satisfy the geographical dispersement requirement. Similarly, in Rutland v. Commissioner, 89 T.C. 1137 (1987), an office building failed to meet the definition of qualifying employer real property because it constituted the only parcel of land being leased to the employer. In Lambos v. Commissioner, 88 T.C. 80 (1987), the geographical dispersement requirement was failed, even though there were three parcels of land, because they were all located in the same county. Also see TAM 8753001, where the parcels were located in the same city and the IRS ruled the parcels did not satisfy the geographical dispersement requirement.

Limitations on the percentage of assets invested in qualifying real property. ERISA 407 limits the percentage of Solo 401k plan assets that can be invested in qualifying employer real property without engaging in a prohibited transaction.

10% is general limit. If a Solo 401k plan acquires qualifying employer real property, the aggregate fair market value of such property held by the plan may not exceed 10% of the fair market value of the Solo 401k plan assets, determined immediately after the acquisition. See ERISA 407(a)(2).

Adequate consideration requirement. The acquisition, sale or lease involving qualifying employer real property is not exempt from the prohibited transaction rules unless it is for adequate consideration. See ERISA 408(e)(1). DOL Reg. 2550.408e(d) provides rules for determining adequate consideration. For a marketable obligation, adequate consideration is determined under ERISA 407(e)(1), which determines the appropriate price based on whether the obligation is acquired on the market, from an underwriter, or directly from the issuer. In all other cases, adequate consideration means a price not less favorable to the Solo 401k plan than the price determined under ERISA 3(18), which is either the price on a generally recognized market, or is the fair market value determined in good faith by the trustee or named fiduciary.

Exemption not available unless no commission is charged on transaction. The prohibited transaction exemption for acquisitions of qualifying real property is not available unless there is no commission charged with respect to the transaction. See ERISA 408(e)(2). A commission includes any fee, commission or similar charge paid in connection with a transaction, except a charge incurred for the purpose of enabling the Solo 401k plan fiduciaries to evaluate the desirability of entering into the transaction (e.g., appraisal or investment advisory fee). See DOL Reg. 2550.408e(e).

Self-dealing by a fiduciary or Trustee of Solo 401k Plan: Solo 401k Prohibited Transaction

A self-dealing prohibited transaction is one that involves a disqualified person (e.g., you as trustee/participant) who is a fiduciary or trustee of his or her Solo 401k. The transaction is prohibited if the fiduciary/trustee deals with the income or assets of the Solo 401k plan in his or her own interest (IRC 4975(c)(1)(E)), or if the fiduciary/trustee receives consideration from a party dealing with the Solo 401k plan in connection with the transaction. This is outlined in the following regulations: (IRC 4975(c)(1)(F)) and ERISA citation is ERISA 406(b)(1) and ERISA 406(b)(3).

Like the use-of-plan-assets transactions described in our previous blog posting dated 8/10/11, the determination of whether a self-dealing transaction has occurred depends upon the facts and circumstances, and is a subjective determination in many cases. The key factor is whether the trustee exercises the authority or control that makes that person a trustee in a way that:

(1) benefits the trustee (or a person in whom the trustee has an interest which may affect the trustee’s best judgment as a trustee), or

(2) causes the trustee to receive consideration from a third party.

Authority over Solo 401k transaction. The key to analyzing a potential self-dealing situation is whether the fiduciary/trustee had the authority to decide whether the solo 401k plan entered into the transaction, and by exercising such authority, the fiduciary/trustee was personally compensated either by the Solo 401k plan or by a third party involved in the transaction.

Noninvolvement of fiduciary/trustee in decision which would otherwise produce self-dealing issue. One key factor in the self-dealing issue is that the fiduciary/trustee must be exercising his or her authority or control with respect to the Solo 401k plan or plan assets which results in a benefit to the fiduciary/trustee, in order for the self-dealing provisions of the prohibited transaction rules to be violated. If the fiduciary/trustee can successfully eliminate himself or herself from the decision regarding a Solo 401k transaction, a prohibited transaction might be avoided. See DOL Reg. 2550.408b-2(e)(2), Advisory Opinion 99-09A and Advisory Opinion 91-37A.

Transactions which might raise self-dealing issues. There have been many court decisions and IRS or DOL rulings regarding the issue of self-dealing. A fiduciary/trustee may be self-dealing by receiving payment directly from the Solo 401k plan in connection with a transaction over which the fiduciary/trustee had authority or control. Sometimes the consideration is from a third party, such as a finder's fee, or other compensation paid by another person involved in the transaction with the Solo 401k plan.

Solo 401k Prohibited Transaction EXAMPLE 1
Gratuities paid to trustees. In Secretary of Labor v. Carell, 17 EBC 1159 (M.D.Tenn. 1993), an administration firm reimbursed the plan trustees for expenses incurred by the trustees' spouses when they attended trustee meetings. The court ruled the payments constituted consideration received by the trustees in connection with plan assets, and constituted self-dealing. Although plan assets were not directly used, the court noted that the gratuities influenced the trustees in their dealings with plan assets. For example, the trustees would be more likely to continue to retain the administration firm to perform services for the plan, and to be compensated with plan assets.

Solo 401k Prohibited Transaction EXAMPLE 2
Compensation received by fiduciary. In an information letter (published at ¶23,881M of the CCH Pension Plan Guide), DOL discussed the circumstances surrounding compensation paid to a trustee of a multiemployer plan for services he provided to the plan's board of trustees. A self-dealing issue may arise with compensation if the fiduciary uses his/her authority to engage himself/herself in activities with the plan for which he will be paid compensation. According to the DOL, the exemption for reasonable compensation for services  does not protect a fiduciary/trustee from self-dealing. To avoid a self-dealing violation, the fiduciary/trustee must not have any authority, control or responsibility over whether he is retained to perform the services for which he/she will be compensated from the Solo 401k plan or through consideration from a third party.

Solo 401k Prohibited Transaction EXAMPLE 3
Mere presence of independent fiduciary/trustee is not enough to ensure no self-dealing. The mere presence of an independent fiduciary/trustee acting on the recommendations of a consultant/adviser is not sufficient to insulate the consultant/adviser from fiduciary/trustee liability under the self-dealing rules. See Advisory Opinions 84-03A and 84-04A. The key is the nature of the services being rendered, and whether such services cause the person to be acting as a fiduciary, as discussed in  above, and whether actions in such capacity result in self-dealing. If there is no explicit or implicit understanding, as manifested either by agreement or by conduct, between the second fiduciary and the consultant/adviser that the second fiduciary will rely on the consultant’s/adviser’s recommendations, the DOL acknowledged in Advisory Opinions 84-03A and 84-04A there would not be a fiduciary relationship between the plan and the consultant/adviser and the self-dealing issues would not arise.

Solo 401k Prohibited Transaction EXAMPLE 4
Transactions with companies related to (or affiliated with) the fiduciary. Where there is a relationship or affiliation between a fiduciary/trustee and another entity or person, a self-dealing issue is raised when that other entity or person benefits, not just if the fiduciary/trustee benefits directly. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209 (2nd Cir. 1987), is an example of self-dealing involving transactions between the plan and companies related to the fiduciary who caused the plans to engage in the transactions. In this case, the fiduciary was the investment manager for the plan. The related companies were a registered broker-dealer and an investment banking corporation. The fiduciary used his authority to invest in companies for which the related companies were engaged to perform services and receive commissions, fees and other consideration.

Solo 401k Prohibited Transaction EXAMPLE 5
Partnership in which fiduciary is a partner. In TAM 9208001, the IRS ruled that a fiduciary engaged in self-dealing when he caused the plan to invest in a loan to a limited partnership in which the fiduciary was a 7.5% partner.

Solo 401k Prohibited Transaction EXAMPLE 6 (note that even though this refers to an IRA it still applies to a Solo 401k)
Transaction between IRA and company owned substantially by IRA owner. The issue of self-dealing was raised by the DOL in Advisory Opinion 2006-01A, where a lease between company owned 68% by the IRA owner (the disqualified person) and an LLC in which the IRA was an investor was determined to be an indirect lease between the IRA and the disqualified person.

Solo 401k Prohibited Transaction EXAMPLE 7
Employer’s exercise of fiduciary to retain entity could result in self-dealing. In DOL Advisory Opinion 97-23A, a plan owned 100% of a corporation that provided administrative services. The DOL discussed the self-dealing issues relating to a participating employer's engaging the corporation to provide administrative services to other plans maintained by that employer. Since the plan-owned corporation is a plan asset, its financial success affects the rate of return of the plan, which, in turn, may reduce the need for employer contributions to the plan (the plan in question was a defined benefit plan). Such effect on the employer's required contributions would constitute an act of self-dealing if the employer was acting as a fiduciary in the transaction.

Solo 401k Prohibited Transaction EXAMPLE 8 (note that even though this refers to an IRA it still applies to a Solo 401k)
IRA owner treated as fiduciary of IRA. In DOL Advisory Opinion 93-33A, the DOL notes that when an individual controls the investments in his IRA, he is a fiduciary for prohibited transaction purposes. (In that ruling, the IRA owner invested his IRA assets in his daughter’s business, and was found to be engaged in a self-dealing transaction). Therefore, if the IRA owner directs investment transactions with IRA assets that personally benefits him, he is engaging in an act of self-dealing under IRC 4975(c)(1)(E) or (F). In the IRA context, the consequence of engaging in a prohibited transaction is not excise taxes under 4975, but rather the loss the IRA’s tax-exempt status, pursuant to IRC 408(e)(1). Nonetheless, DOL Advisory Opinion 93-33A, and other Advisory Opinions that have dealt with IRA transactions (see, for example, Advisory Opinion 2000-10A, and Advisory Opinion 2006-01A, which have consistently applied the fiduciary concepts to the IRA owner that directs the investments of the IRA, but solely for purposes of determining whether the IRA engages in a prohibited transaction. Some court cases which have treated the IRA owner as fiduciary of his IRA include Swanson v. Commissioner, 106 T.C. 76 (1996), and Harris v. Commissioner, 67 T.C.M. 1983 (1994).

Solo 401k Prohibited Transaction EXAMPLE 9 (note that even though this refers to an IRA it still applies to a Solo 401k)
IRA transactions that may raise self-dealing issues. The DOL has raised the issue of self-dealing when an IRA purchases stock in a company in which the IRA owner owns stock, or is a director or officer. The issue is a factual one - does the purchase result in a direct or indirect benefit to the IRA participant (other than in his capacity as the participant in the IRA)? In DOL Advisory Opinion 89-03A, an IRA owner directed the purchase of common stock in the company which employed the IRA owner. The IRA owner was also an owner in that company, but owned only slightly more than 1% of that company. The DOL's discussion indicates that the degree of ownership is a factor here (i.e., the smaller the IRA owner's personal stake in the company and the IRA's ownership in the company, the less likely the investment will result in self-dealing). Also see DOL Advisory Opinion 90-20A (employee of approved nonbank trustee of IRA directing purchase of employer’s stock by IRA).

Solo 401k Prohibited Transaction EXAMPLE 10 (note that even though this refers to an IRA it still applies to a Solo 401k)
Investment of IRA in limited partnership in which IRA owner is a partner. DOL Advisory Opinion 2000-10A deals with an IRA invested in a limited partnership in which the IRA owner was the general partner and family members of the IRA owner had limited partnership interests. The DOL did not find a prohibited transaction arising from the sale of the partnership interest to the IRA because the partnership itself, based on its ownership structure, was not a disqualified person with respect to the IRA (the IRA only had a 39.38% limited partnership interest in the partnership). But the DOL cautioned about possible conflicts of interest that could result in prohibited transactions under IRC 4975(c)(1)(D) or (E), although it did not rule on these issues because of their factual nature. For example, there could be conflicts of interest later on with respect to the IRA’s investment in the partnership since the IRA owner also is the general manager of the partnership. Also, the IRA owner cannot be otherwise dependent upon the participation of the IRA in order for the IRA owner to continue his individual ownership in the partnership. The DOL also noted that, since the IRA owns more than 25% of the partnership, and the partnership is an investment club, the underlying assets of the partnership are treated as IRA assets pursuant to DOL Reg. 2510.3-101. Thus, any person who exercises discretionary authority or control over the partnership’s assets would be treated as a fiduciary of the IRA for purposes of applying the prohibited transaction rules under IRC 4975.

Use of Solo 401k plan assets by disqualified person: Prohibited Transaction

The income or assets of the Solo 401k may not be transferred to, or used by or for the benefit of, a disqualified person (e.g., the trustee, spouse, son, daughter, mother, father).See ERISA 406(a)(1)(D).

This type of transaction is fact-specific, meaning the IRS and DOL will analyze whether under the circumstances a personal benefit is being derived by the disqualified person from the transaction involving Solo 401k plan assets. This is a highly subjective analysis.

Exemptions

Fair market value transactions with service providers. IRC 4975(d)(20), as added by section 611(d) of the PPA 2006, provides for an exemption from the prohibited transactions for a use of Solo 401k plan assets described in IRC 4975(c)(1)(D) if:

(1) the transaction is between a Solo 401k plan and a disqualified person who is not a fiduciary (or affiliate) who has or exercises authority or control over the investment of the Solo 401k plan assets involved in the transaction nor provides investment advice with respect to such assets,

(2) the person is a disqualified person solely by reason of providing service to the Solo 401k plan or solely by reason of a relationship to such service provider described in IRC 4975(e)(2)(F), (G), (H), or (I), and

(3) the plan receives no less than, or pays no more than, adequate consideration for the transaction. This exemption applies for qualifying transactions that occur after August 17, 2006.

Exemptions Continued

Payment of benefits to participant who is a disqualified person. Payment of benefits to a disqualified person, in his capacity as a Solo 401k plan participant or beneficiary, is not a prohibited transaction. IRC 4975(d)(9). Note, however, that because of the way 4975(c) is so broadly written, this statutory exemption was necessary to prevent the payment of benefits from being a prohibited transaction.

Prohibited Solo 401k Transactions Examples

Example 1 of prohibited Solo 401k Transaction:

Loans to firm's clients. In TAM 9238003, the IRS ruled that loans by a law firm's profit sharing plan to the firm's clients were prohibited transactions. The assets were being used for the benefit of the law firm, by allowing clients to receive loans from the plan as an "advance" for personal injury settlements that would later be obtained for the client by the law firm.

Example 2 of prohibited Solo 401k Transaction:

Transfer to employer's checking account. In TAM 9316001, the IRS ruled that the transfer of plan assets to the employer's checking account was a prohibited transaction, where the employer used the funds in the checking account for corporate purposes. Although benefits payable from the plan were paid from the checking account, the employer was not acting solely in an agency capacity with respect to the transfers. Plan assets were transferred without regard to whether they were immediately payable as benefits, and the employer had discretion to use the checking account for any purpose. This is why it is vital to open the Solo 401k checking account under the name of the Solo 401k trust using its EIN, instead of under the name of your company and your social security number.

Example 3 of prohibited Solo 401k Transaction:

Loan transaction to several companies enhanced value of their stock, providing indirect benefit to a party-in-interest who owned minority interests in the companies. Rollins v. Commissioner, 34 EBC 2523 (Tax Ct. November 15, 2004) contains great information of the prohibited transaction described in IRC 4975(c)(1)(D). Rollins was the 100% shareholder of a professional corporation that maintained a 401(k) plan. The plan extended several loans to three different companies. Rollins had a minority interest in each company in the following amounts: (1) an 8.93% interest in J&J Charlotte, with almost 30 other owners, the next highest ownership percentage being 6.25%, (2) a 26.8% interest in Eagle Bluff, with more than 80 other partners, the next highest ownership percentage being 8.8197%, and (3) a 33.165% interest in Jocks and Jills, with more than 70 other partners, the next highest ownership percentage being 4.8809%. In each case, the loan was a 12% demand note collateralized with assets of the borrower. Rollins’ ownership was not sufficient to make any of the companies a party-in-interest with respect to the plan. Thus, the loans were not direct prohibited transaction under IRC 4975(d)(1)(B), in that the recipients of the loans were not parties-in-interest. However, the court agreed with the IRS that the loans constituted the prohibited use of plan assets for the benefit of a disqualified person (i.e., Rollins), within the meaning of IRC 4975(c)(1)(D). The court noted that a "use of plan assets" need not involve an actual transfer of plan assets to the disqualified person in order to fall within the purview of IRC 4975(c)(1)(D). The benefit obtained by the disqualified person can be a direct one or an indirect one. Evidence that Rollins may have benefited from the transactions is that these companies were able to secure financing without having to deal with independent lenders, which enhanced the value of Rollins' equity interests in the companies. The use of a plan assets to enhance the price of a security can also constitute a benefit within the meaning of IRC 4975(c)(1)(D). See H.Conf. Rept. 93-1280, at 303, 1974-3 C.B. at 469. The burden of proof is on Rollins to demonstrate that, by a preponderance of the evidence, the loans did not constitute uses of the plan's income or assets for his own benefit. Rollins failed to carry that burden.

Example 4 of prohibited Solo 401k Transaction: (note that although IRA is used, this still applies to a Solo 401k)

Indirect lease between IRA and company substantially owned by IRA owner. In Advisory Opinion 2006-01A, the DOL ruled that a lease between a company owned 68% by an IRA owner (the disqualified person) and an LLC in which the IRA was an investor constituted an indirect lease between the IRA and the disqualified person. It also constituted the use of IRA assets for the benefit of the disqualified person, in violation of IRC 4975(c)(1)(D).

Solo 401k Prohibited Transactions: Furnishing of Goods, Services, or Facilities

The Solo 401k plan may not furnish goods, services or facilities to a disqualified person (e.g., your son, father, spouse), nor may the disqualified person furnish goods, services or facilities to the Solo 401k plan. See ERISA 406(a)(1)(C).

Exemption exists for reasonable compensation for reasonable services. ERISA 408(b)(2) provides relief from the prohibited transaction rules for service contracts or arrangements between a Solo 401k plan and a disqualified person/party-in-interest if:

(1) The contract or arrangement is reasonable

(2)the services are necessary for the establishment or operation of the Solo 401k plan, and

(3)no more than reasonable compensation is paid for the services.

This exemption is commonly referred to as the ERISA 408(b)(2) exemption.

See DOL Reg. 2550.408b-2 and Treas. Reg. 54.4975-6 which contain additional rules about this exemption.

Because the DOL has primary regulatory authority with all prohibited transaction issues, with the exception of collecting excise taxes under IRC 4975, it is through this exemption that a service provider (e.g., Solo 401k administrator) may receive payment for services directly from Solo 401k plan assets. "Services" for this purpose includes the provision of goods or facilities (e.g., leasing of space by the Solo 401k plan).

What's considered reasonable compensation? Reasonable compensation is determined on facts and circumstances. See Treas. Reg. 54.4975-6(e) which discusses payment of compensation. Also, Treas. Reg. 1.162-7 discusses excessive compensation.

Important: Self Dealing: The exemption for reasonable compensation does not apply to self-dealing transactions under 4975(c)(1)(E) and (F). This is supported by IRS and DOL. Treas. Reg. 54.4975-6(a)(5)(i) and DOL Reg. 2550.408b-2(e)

Prohibited Solo 401k Transactions: Lending of Solo 401k plan assets or other extension of credit

The Solo 401k plan may not lend money, or otherwise extend credit to a disqualified person (e.g., your spouse, daughter, father, to name a few) nor may disqualified person loan money, or otherwise extend credit, to the Solo 401k plan. See ERISA 406 (a) (1)(B).

This includes direct or indirect transactions.

EXAMPLE: Indirect benefit derived from trustee who authorizes the plan loan. A loan to a partnership in which one of the trustees had a 39% partnership interest was ruled to be a prohibited transaction in TAM 9119002 because it was an indirect loan from the plan to the trustee who was a partner of the borrowing partnership.

EXAMPLE: Loan to a disqualified person. Fred's Solo 401k plan has cash balance of $300,000. His Son recently started a new business and needs a short-term loan. Fred offers his son $100,000 in exchange for a promissory note paying ten percent interest in 64 monthly installments. This would be considered a prohibited transaction-lending of money or other extension of credit between a plan (Solo 401k) and a disqualified person (Fred's son).

Solo 401k loans to trustee (participant) are allowable. Provided the Solo 401k plan document allows for participant loans, a loan from the Solo 401k plan to the trustee is not considered a prohibited transaction as long as all the Solo 401k participant loan documents are completed. In this case, the disqualified person is receiving the Solo 401k participant loan in her capacity as a Solo 401k plan participant, and an exemption is available under ERISA 408(b)(1) as long as the loan program rules are satisfied. For more information on Solo 401k participant loans, visit: www.mysolo401k.net/Solo401kLoan.html

Loans with substantially-owned businesses/attribution of ownership. Where a business is substantially owned (i.e., 50% or more) by a Solo 401k plan's Trustee, the company, a service provider (e.g., the Solo 401k's accountant), a prohibited transaction occurs with respect to loans between the Solo 401k plan and such business. Reason being, under the definition of a disqualified person under IRC 4975(e)(2)(G) indirect ownership through family attribution all disqualified parties are lumped together to determine the 50% or more ownership rule. An example of this is illustrated in DOL Advisory Opinion 2006-09A, involving an IRA and a corporation substantially owned by the IRA owner's daughter and son-in-law, where investment in corporate notes would result in a prohibited loan. Here is the link to this DOL Advisory Opinion: www.dol.gov/ebsa/regs/aos/ao2006-09a.html

SOLO 401K PROHIBITED TRANSACTION ANALYISIS: Sales, Exchanges and Leases

The Solo 401k plan may not sell or exchange property, or lease property, to a disqualified person, nor may a disqualified person sell or exchange property, or lease property to the Solo 401k plan. See ERISA 406(a)(1)(A).

This includes direct or indirect transactions. For example, a sale of property by the Solo 401k plan to a third party, where the sale is for the purpose of the third party selling the property to a disqualified person, would be an indirect sale between the Solo 401k plan and the disqualified person.

Examples of prohibited Solo 401k loans or leases

EXAMPLE 1 - sale between Solo 401k plan and service provider. Mary is an accountant. She prepares Form 5500s for ABC Company's Solo 401k plan. The ABC Solo 401k plan owns a house which the trustee of the Solo 401k is trying to sell. Mary agrees to purchase the property. An appraisal of the property states that the value of the property is $250,000. The Solo 401k plan trustee agrees to sell the property to Mary for $250,000. The sale is a prohibited transaction because, as a service provider to the plan, Mary is a disqualified person.

EXAMPLE 2 - lease between Solo 401k plan and daughter of Solo 401k plan trustee. A Solo 401k owns an apartment building. One of the tenants is Rachel, the daughter of the plan's trustee. As a party-in-interest, Rachel's leasing of the apartment is a prohibited transaction, because the apartment is Solo 401k asset. This is true even if the lease is for a fair market rental value.

EXAMPLE 3 - sale between Solo 401k Plan and its Trustee. Larry holds a parcel of land in his Solo 401k plan. Larry has decided to retire and wants to build a retirement home on the property. After having the property appraised, Larry purchases the property from his Solo 401k. Larry's purchase of property from his Solo 401k plan is prohibited transaction because the property is a Solo 401k asset.

However, had Larry instead taken receipt of the property through a distribution from his Solo 401k plan, which would be reported to the IRS on form 1099-R, and paid the applicable income taxes (assuming that the property had been purchased with non Roth Solo 401k funds), he could then personally own the property. Note that earnings from Solo 401k Roth are not subject to income taxes.

Indirect sales and leases. Prohibited transactions also can occur as an indirect transaction between the Solo 401k and a disqualified person. This might occur when an intermediary is used to arrange a transaction that has the effect of a sale or lease between the Solo 401k and a disqualified person. For an example, see DOL Advisory Opinion 2006-01A, where a lease between an LLC and a corporation, where only the corporation was a disqualified person with respect to an IRA, was treated by the DOL as a prohibited transaction because it resulted in an indirect lease between the IRA and the S corporation.

In other words, if a Solo 401k transaction directly violates the prohibited transaction rules, simply altering the transaction to remove the disqualified person from direct involvement is insufficient. So merely insulating that person from the transaction and enlisting a third party does not make a prohibited transaction permissible. Under the Solo 401k prohibited transaction rules, a disqualified person may not indirectly do what cannot be done directly.

EXAMPLE: Mike used his Solo 401k plan to invest in a rental property. Mike would now like to purchase the rental house from his Solo 401k. Mike's direct purchase from the Solo 401k plan is clearly a prohibited transaction because Mike is a disqualified person, and the Solo 401k plan cannot have a sale between itself and such a party. So, as trustee of his Solo 401k plan Mike sells the property to John, a person unrelated to Mike. John and Mike, however, have agreed that Mike will immediately purchase the property from John after the transaction between John and the Solo 401k plan is completed. This is an indirect prohibited transaction because Mike, as a disqualified person, attempts to circumvent the prohibited transaction rules by bringing a third party (John) into the transaction.

Gold and all other metals in Solo 401k: List of Allowable Precious Metals in Solo 401k Include:

Use this guide when determining precious metals to purchase with your Solo 401k.


GOLD

Ø  American Eagle Coins (however, coins including the American Eagle, that have undergone “certification”—also known as “slabbed” coins—are not acceptable in Solo 401k at this time)

Ø  Australian Kangaroo/Nugget coins

Ø  Austrian Philharmonic coins

Ø  Canadian Maple Leaf coins

Ø  Credit Suisse-Pamp Suisse Bars .999

Ø  U.S. Buffalo Gold Uncirculated coins (no Proofs)

Ø  Bars and rounds (produced my manufacturers accredited by Nymex/Comex, LME, LBMA, NYSE/Liffe/CBOT, and ISO-9000 or a national mint. The minimum finesses for bars are:

·         Gold .995+

PLATINUM

Ø  American Eagle coins(however, coins including the American Eagle, that have undergone “certification”—also known as “slabbed” coins—are not acceptable in Solo 401k at this time)

Ø  Australian Koala coins

Ø  Canadian Maple Leaf coins

Ø  Isle of Man Noble coins

Ø  Bars and rounds (produced my manufacturers accredited by Nymex/Comex, LME, LBMA, NYSE/Liffe/CBOT, and ISO-9000 or a national mint. The minimum finesses for bars are:

·         Platinum .9995+

SILVER

Ø  American Eagle coins (however, coins including the American Eagle, that have undergone “certification”—also known as “slabbed” coins—are not acceptable in Solo 401k at this time)

Ø  Australian Kookaburra coins

Ø  Austrian Vienna Philharmonic coins

Ø  Canadian Maple Leaf coins

Ø  Mexican Liberated coins

Ø  Bars and rounds (produced my manufacturers accredited by Nymex/Comex, LME, LBMA, NYSE/Liffe/CBOT, and ISO-9000 or a national mint. The minimum finesses for bars are:

·         Silver .9995+

PALLADIUM

Ø  Bars and rounds produced my manufacturers accredited by Nymex/Comex, LME, LBMA, NYSE/Liffe/CBOT, and ISO-9000 or a national mint. The minimum finesses for bars are:

           Palladium .9995+

Disallowed Precious Metals in Solo 401k Include:

      Austrian 100, 20 and 10 Corona

      Belgian 20 Franc

      British Britannia

      Chilean 100 Peso

      Columbian 5 Peso British Sovereign

      Dutch 10 Guilder

      French 20 Franc

      Hungarian 100 Korona

      Italian 20 Lira

      Mexican 50, 20, 10, 5, 2 ½, and 2 Peso

      Rare or Collectible Coins

      South African Krugerrand

      Swiss 20 Franc


Learn about procedure for investing Solo 401k in precious metals such as coins and gold bars by reading following blog post: http://www.mysolo401k.net/Blog-for-MySolo401k.html?entry=how-to-purchase-precious-metals

Prohibited Transaction Rules Applicable to Solo 401k

The prohibited transaction rules are found under IRC Sec. 4975 and ERISA Sec. 406. Both sections take on prohibited transactions mirror each other. However, the tax consequences and penalties for running afoul with the IRC 4975 PT rules are vastly harsher than breaking the rules applicable to ERISA Sec. 406. 

The reason for the prohibited transaction rules is to protect the assets of the Solo 401k participant(s) by disallowing dealings between the Solo 401k and persons who may have conflicts of interest with the Solo 401k. ERISA Sec. 408 lists statutory exemptions to the prohibited transaction rules which parallel those found in IRC 4975(d).

Certain transactions that would normally be considered prohibited have been exempt from the ERISA Sec. 406 prohibited transaction rules and are known as statutory exemption provisions. They are:

1. Exemption for participant loans (that is, taking a participant loan from your Solo 401k). See Reg. 2550.408b-1
2.Exemption for services or office space--see 2550.408b-2

Additional regulations relating to the acquisition and holding of employer securities and employer real property are in DOL Reg. 2550.407a-1 through 2550.407a-4, 2550.407c-3, 2550.407d-5 and 2550.407d-6.

As you can see, when determining whether a particular Solo 401k transaction is prohibited, you should ascertain if any applicable exemptions apply, such as the ones listed above.

In upcoming blog posts, we will discuss and provide examples of the various types of transactions that are prohibited under ERISA Sec. 406.

 Upcoming Blog Titles Pertaining To Prohibited Transactions Relating to Solo 401k

--The 1st blog will be labeled Sales, Exchanges and Leases;

--The 2nd blog will be labeled Loans;

--The 3rd blog will be labeled Goods and Services;

--The 4th blog will be labeled Use of Assets;

--The 5th blog will be labeled Self-Dealing; and

--The 6th blog will be labeled Investments in Qualifying Employer Securities and Qualifying Employer Real Property.