Solo Tax Rules for 401(k) Contributions and Reporting Explained
Understand how solo 401(k) contributions and reporting work, including tax implications, filing requirements, and key rules for self-employed individuals.
Saving for retirement as a self-employed individual comes with unique challenges, but a Solo 401(k) offers significant tax advantages and higher contribution limits. Understanding the rules governing contributions and reporting is essential to maximize benefits while staying compliant with IRS regulations.
Single-Participant Plan Essentials
A Solo 401(k), also called a one-participant 401(k), is for self-employed individuals and business owners with no employees other than a spouse. Unlike traditional employer-sponsored plans, the business owner acts as both employer and employee, providing flexibility in contributions and investments. The plan follows standard IRS regulations but with fewer administrative requirements.
One advantage is the ability to invest in a wide range of assets, including real estate, private equity, and cryptocurrency, though these require strict adherence to IRS rules. The plan must be established by December 31 of the tax year, but contributions can be made until the tax filing deadline, including extensions.
Once plan assets exceed $250,000, the IRS requires filing Form 5500-EZ. Failing to submit this form can result in penalties, making accurate record-keeping essential.
Employer and Employee Contributions
A Solo 401(k) allows contributions as both an employee and an employer. The 2024 employee contribution limit is $23,000, with a $7,500 catch-up contribution for those 50 or older. Contributions can be pre-tax, reducing taxable income, or Roth, allowing tax-free withdrawals in retirement.
Employer contributions are based on net earnings from self-employment, calculated as net profit minus half of self-employment tax and any employee contributions. Employers can contribute up to 25% of this amount. The combined total of employee and employer contributions cannot exceed $69,000 for 2024, or $76,500 with catch-up contributions.
Employee deferrals must be elected by December 31, while employer contributions can be made until the tax filing deadline, including extensions. Contributions exceeding IRS limits must be corrected promptly to avoid penalties.
Self-Employment Tax Considerations
Self-employed individuals pay both the employer and employee portions of Social Security and Medicare taxes, totaling 15.3% for 2024. This includes 12.4% for Social Security on earnings up to $168,600 and 2.9% for Medicare on all net earnings. Income above $200,000 for single filers or $250,000 for married couples filing jointly incurs an additional 0.9% Medicare surtax.
Employer contributions lower taxable income but do not reduce self-employment tax, as this tax is calculated before deducting employer contributions. However, the deduction for employer contributions lowers adjusted gross income (AGI), which can impact eligibility for certain tax deductions and credits.
Accurately calculating net earnings ensures compliance and prevents underpayment penalties. Deducting business expenses and half of self-employment tax before determining the maximum employer contribution is necessary. IRS Schedule SE helps report self-employment tax correctly, while estimated quarterly tax payments help avoid penalties.
IRS Reporting Requirements
Solo 401(k) plans with assets exceeding $250,000 at year-end must file Form 5500-EZ, which reports plan details, including total assets, contributions, and distributions. Failing to file can result in significant penalties.
Tax-deferred Solo 401(k) plans must comply with required minimum distribution (RMD) rules starting at age 73. Roth Solo 401(k) balances are exempt from RMDs beginning in 2024 under the SECURE 2.0 Act, but pre-tax funds must follow IRS life expectancy tables for distributions. These withdrawals must be reported on Form 1099-R. Plan administrators typically issue this form, but self-managed plans require the account holder to ensure proper reporting.
Penalties for Late or Incomplete Filings
Failing to meet IRS reporting requirements can result in financial penalties. If Form 5500-EZ is not filed on time when required, the IRS imposes a penalty of $250 per day, up to $150,000 per year.
Excess contributions not corrected by the IRS deadline incur a 10% excise tax each year they remain in the account. Late required minimum distributions (RMDs) carry a 25% excise tax on the amount not withdrawn, though this can be reduced to 10% if corrected in a timely manner.
The IRS offers the Employee Plans Compliance Resolution System (EPCRS) to correct mistakes before penalties escalate. Keeping accurate records and reviewing filings annually helps avoid compliance issues.