Solo 401k Contribution Questions for tax year 2012 and beyond

 Hello,

Question: I started self employment this year and have an LLC taxed as a sole proprietor. I have some very basic questions surrounding Self-Directed Solo 401k as an alternative to IRAs, such as does income need to be deferred as it’s received or can lump sum payments be made, or both.... not sure on the profit sharing piece either. Are these questions you can help with please?

Thanks,

J. Paul

Answer: Both contribution types (explained below) to Self-Directed Solo 401k may be made as income is earned or by your tax return due date plus extensions.  Therefore, you have option to estimate your net income from self-employment for the year and therefore make early Solo 401k contribution(s); however, you might run the risk of over contributing to your Solo 401k if you over estimate your net earnings from self employment. If you do over estimate your net-earnings from self-employment, you will generally need to remove the amount plus earnings by your tax return due date plus extensions.

Contributions to Self-Directed Solo 401k (a/k/a owners-only 401k, self-employed 401k, Solo 401k, etc.) are made up of two (2) types:

Type 1: Employee/Salary Deferral Contributions are made up of maximum contribution amount of $17,000 for tax year 2012 subject to change for tax year 2013 and beyond based on whether to contribution limits are increased or decreased by the government.

Type 2: Employer/Profit Sharing Contributions: For a sole proprietor, the maximum Solo 401k contribution is 20% of net-income from self-employment. When calculating profit sharing calculation, be sure to first add back the Type 1-Employee so that you can maximize your profit sharing contribution.

Example: If you make $17,000 Solo 401k employee contribution for tax year 2012 based on $150,000 of net income from self-employment, you would calculate your Type 2 –Profit Sharing contribution on $150,000 not $133,000 [$150,000 - $17,000].

IMPORTANT: If you make the full $17,000 Employee (Type 1) contribution, you may only make maximum Profit Sharing contribution (Type 2) of $33,000 in order to not exceed the annual $50,000 contribution limit for tax year 2012.

Free Solo 401k Calculator: Use/click on following Solo 401k contribution calculator to easily and accurately calculate your annual 2012 Solo 401k contribution. The Solo 401k calculator will breakdown both contribution types—Employee and Employer for you as well as deduct the ½ self-employment tax and confirm that a Solo 401k is the best plan for the self-employed when looking to maximize contributions when compared to SEP and SIMPLE IRA.

Maximum Solo 401k Contribution for 2012 Tax Year:  The maximum annual Solo 401k contribution for tax year 2012 is the lesser of:

100% of your compensation

$50,000 (or $55,000 if age 50 or older, known as Solo 401k catch-up contribution.

Contribution deadline: As self-employed, you can delay making part or all of your annual Solo 401k contribution up to the due date of your tax return including extensions.

Self-employed income that qualifies for Solo 401k contributions: Only net earnings (compensation) from the self-employed business that the Solo 401k plan was setup for may be incorporated towards your annual Solo 401k contribution calculation. You cannot make Solo 401k contribution if you have no net income from self-employment.

Deducting Solo 401k Contributions for business taxed as Sole Proprietor: if you are taxed as a sole proprietor, you will deduct your Solo 401k contribution on Form 1040 line 28.

Solo 401k Establishment Deadline:  I you are planning to make Solo 401k contribution for tax year 2012, you are required to Open Solo 401k by December 31, 2012. This translates to executing the Solo 401k establishment documents by 12/31/2012.  This will allow you to delay making your 2012 Solo 401k contribution until 2013, the year that you file your tax return.

Tracking and Documenting Annual Solo 401k Contributions: It is important to document your annual Solo 401k contributions, especially if you have opened a Solo 401k checkbook control account. Reason being, you are serving as the Trustee of the Solo 401k and therefore are responsible for marinating good records, especially in the event of an IRS audit.  While the Solo 401k bank account will serve as the primary tool to track annual Solo 401k contributions, you should also document your annual Solo 401k contributions using a form. Not all Solo 401k providers offer free Solo 401k forms for tracking Solo 401k contributions or documenting Solo 401k investments. You can access free Solo 401k contribution form to formally document your annual Solo 401k contributions as well as other forms, by visiting Free Solo 401k Forms