Solo 401K plan contributions for Self-employed

[swongtax]

Hello all,

I am researching Solo 401K plans for Self-employed individuals, and I am having trouble understading the logistics of the IRS rules, it sounds very confusing.

See IRS publication 560, Chaptes 2, 4, 6.

Below are the steps for calculating  "maximum Deductible Contribution" for the self-employed taxpayer.  I am confused as to why it is necessary to go through this entire calculation.  It sounds like even if the taxpayer is able to contribute the maximum $19500 per year (under age 50) based on the net profit limitations, it does not mean that this entire amount could be deductible (as pre-tax contribution) on Schedule 1, Line 15.  Is this the purpose of the step by step instructions below?

SW

6. Table and Worksheets for the Self-Employed

As discussed in chapters 2 and 4, if you are self-employed, you must use the rate table or rate worksheet and deduction worksheet to figure your deduction for contributions you made for yourself to a SEP-IRA or qualified plan.

First, use either the rate table or rate worksheet to find your reduced contribution rate. Then, complete the deduction worksheet to figure your deduction for contributions.

.

The table and the worksheets in chapter 6 apply only to self-employed individuals who have only one defined contribution plan, such as a profit-sharing plan. A SEP plan is treated as a profit-sharing plan. However, don't use this worksheet for SARSEPs..

Rate Table for Self-Employed.

 

If your plan's contribution rate is a whole percentage (for example, 12% rather than 12½%), you can use the Rate Table for Self-Employed on the next page to find your reduced contribution rate. Otherwise, use the Rate Worksheet for Self-Employed provided below.

First, find your plan contribution rate (the contribution rate stated in your plan) in Column A of the table. Then, read across to the rate under Column B. Enter the rate from Column B in step 4 of the Deduction Worksheet for Self-Employed on this page.

Example.

 

You are a sole proprietor with no employees. If your plan's contribution rate is 10% of a participant's compensation, your rate is 0.090909. Enter this rate in step 4 of the Deduction Worksheet for Self-Employed on this page.

Deduction Worksheet for Self-Employed

	Step 1
		Enter your net profit from Schedule C (Form 1040), line 31; Schedule F (Form 1040), line 34;* or Schedule K-1 (Form 1065),* box 14, code A.** For information on other income included in net profit from self-employment, see the Instructions for Schedule SE (Form 1040)	_____
		* Reduce this amount by any amount reported on Schedule SE (Form 1040), line 1b.
		** General partners should reduce this amount by the same additional expenses subtracted from box 14, code A, to determine the amount on line 1 or line 2 of Schedule SE (Form 1040).
	Step 2
		Enter your deduction for self-employment tax from Schedule 1 (Form 1040), line 14	_____
	Step 3
		Net earnings from self-employment. Subtract step 2 from step 1	_____
	Step 4
		Enter your rate from the Rate Table for Self-Employed or Rate Worksheet for Self-Employed	_____
	Step 5
		Multiply step 3 by step 4	_____
	Step 6
		Multiply $285,000 by your plan contribution rate (not the reduced rate)	_____
	Step 7
		Enter the smaller of step 5 or step 6	_____
	Step 8
		Contribution dollar limit	$57,000
		•	If you made any elective deferrals to your self-employed plan, go to step 9.
		•	Otherwise, skip steps 9 through 20 and enter the smaller of step 7 or step 8 on step 21.
	Step 9
		Enter your allowable elective deferrals (including designated Roth contributions) made to your self-employed plan for the 2020 plan year. Don't enter more than $19,500	_____
	Step 10
		Subtract step 9 from step 8	_____
	Step 11
		Subtract step 9 from step 3	_____
	Step 12
		Enter one-half of step 11	_____
	Step 13
		Enter the smallest of step 7, step 10, or step 12	_____
	Step 14
		Subtract step 13 from step 3	_____
	Step 15
		Enter the smaller of step 9 or step 14	_____
		•	If you made catch-up contributions, go to step 16.
		•	Otherwise, skip steps 16 through 18 and go to step 19.
	Step 16
		Subtract step 15 from step 14	_____
	Step 17
		Enter your catch-up contributions (including designated Roth contributions), if any. Don't enter more than $6,500	_____
	Step 18
		Enter the smaller of step 16 or step 17	_____
	Step 19
		Add steps 13, 15, and 18	_____
	Step 20
		Enter the amount of designated Roth contributions included on steps 9 and 17	_____
	Step 21
		Subtract step 20 from step 19. This is your maximum deductible contribution	_____
	Next: Enter your actual contribution, not to exceed your maximum deductible contribution, on Schedule 1 (Form 1040), line 15.

[TaxGuyBill · Accepted solution]

The table/calculation is for the EmployER contribution.

But with a 401k, there can be the 'employee' elective deferral contribution.  Because of that, that table/calculation may not be needed if the contributions are made early enough and the contributions aren't gigantic.  I think the employee contributions need to be "elected" to be 'made' by December 31st, versus the employer contributions don't need to be figured out and made until the due date.

Does that help?

[swongtax]

Thank you but I am still confused, and I just realized that I mistakenly reported the Employer matching contribution amount on Schedule C Pension/Profit sharing line instead of Schedule 1, Line 15 (See below description in BOLD). 

However, on the Proseries Basic software, I am trying to redo this correctly on Schedule 1 Line 15, but when I click the box that says Calculate Maximum Allowed Contribution, the step by step calculations will add both the Employee and Employer Contributions and then somehow end up with a "Maximum Deductible contribution" amount, which is a bigger number than the two numbers combined.  This number then becomes an adjustment that goes back on Form 1040 (to decrease taxable income).  Why would the "Maximum deductible Contribution amount" be greater than the sum of the Elective Deferral contribution amount plus the Employer contribution amount?  This does not make much sense to me.

SW

Important Distinction for Claiming Contributions

Important note: you do not report the employee portion of the Solo 401k contribution on Schedule C. The purpose of Schedule C is calculating your business expenses before determining your earned income from the business.

For pass-through businesses, the employee and employer portion of the Solo 401k contribution is reported on line 15 of Schedule 1. There is a direct connection from Schedule C to Schedule 1. For example, you report business (earned income) from Schedule C on line 3 of Schedule 1. Then, as part of the Schedule 1 calculation, the employer contribution to your Solo 401k becomes part of your adjusted income. Afterward, that is subtracted out of your taxable income. Finally, report adjusted income on line 8a of Schedule 1 on your 1040 form (see line 8b subtraction calculation).

[TaxGuyBill]

Are you SURE the taxpayer is under age 50?  Double check the birthdate.  Is the amount it is deducting $6500 more than the two combined amounts?

Are you looking through the calculation on that retirement worksheet?

[swongtax]

I figured it out!

ON THE PROSERIES KEOGH, SEP, AND SIMPLE CONTRIBUTIONS WORKSHEET(linked to Schedule 1, Line 15), UNDER "INDIVIDUAL 401K", enter the amount of Elective Deferral to the Individual/Solo 401k, then enter the Employer contribution amount. Once those two numbers are entered, the total should be the sum.  But in case one is concerned whether the Employer Contribution is over the limit allowed or under the maximum allowed, click the box to --->Calculate the Maximum Deductible Contribution (EMPLOYER PORTION).  Once clicked, the program automatically calculates the MAXIMUM deductible Contribution (sum of Employee and Employer) and puts the maximum amount on Schedule 1 Line 15 and Form 1040.  This is for planning purposes.

To check this, I increased the Employer Contribution amount and see what would happen if the sum of the two numbers exceeded the MAXIMUM deductible Contribution amount calculated by Proseries, and the amount will stay the same (euqal to the maximum number) even if the Employer contribution plus the Employee deferral contribution added together is too high since the limit is reached.

So, the box (to calculate the maximum deductible amount) is for planning/informational purposes only.  It should not be checked on the finalized return.  

Also, for those who might be struggling to understand (like me) why the Employer contribution should not be deducted on Schedule C, Line 19, Penson/Profit sharing/Qualified plan line.  I did some more research and this is because Employer contribution refers to contributions contributed to the "employees" only, which does not include the Self-employed taxpayer (Pass-through Sole propriertorship or single member LLC treated as a regarded entity, etc).  This is the initial mistake that I made!  Sigh....

Thank you to TaxGuyBill for trying to help clarify this!

I spent so much time trying to read and understand the IRS Publication 560 description on this topic.  The IRS language is extremely confusing!  Wish it was more clearly written.

SW

[qbteachmt]

As for, "I am confused as to why it is necessary to go through this entire calculation." you have a provision that is available for an employee or a self-employed person, applies to the SE/LLC person as both the employer and the employee side of that relationship; and the evaluation for how much is "earned" is much simpler when the person is paid via payroll.

"I mistakenly reported the Employer matching contribution amount on Schedule C Pension/Profit sharing line instead of Schedule 1, Line 15 (See below description in BOLD)."

Is your person an S Corp sole shareholder-employee; a Sole Proprietorship; has earnings allocated from an LLC?

See if this IRS article, with an example, is helpful:

https://www.irs.gov/retirement-plans/one-participant-401k-plans

[qbteachmt]

I guess we were typing at the same time. This part: "I did some more research and this is because Employer contribution refers to contributions contributed to the "employees" only, which does not include the Self-employed taxpayer" was exactly where I was pointing you. Glad you figured it out.

[George4Tacks]

@swongtax Try reading the code https://www.law.cornell.edu/uscode/text/26/401 scroll down to the (k) section. This may help you to appreciate the Reader's Digest versions offered by IRS and various financial institutions. 

Also, show appreciation for answers received by clicking the "Cheers" button. 

I am glad you figured it out and that you asked so clearly. 

[qbteachmt]

George is one of the best for circular math.

[swongtax]

Yes, I did spend quite a long time reading this page already in the past week, but it didn't help me as far as trying to figure out what the Self-employed Worksheet or rate sheet for individual 401K was all about.

Cheers!

SW

[PATAX]

@George4Tacks you are right George people should hit the thumbs up button to let the respondent know that they have read their response and appreciate it... It would also be nice if people would hit the accept as solution button when someone took the time to answer their question... But that is just my opinion

[swongtax]

Can you point me to the IRS publication page that actually describes my understanding?

Thank you!

SW

Employer contribution refers to contributions contributed to the "employees" only, which does not include the "Self-employed taxpayer".

[swongtax]

Also, I did further question regarding the deductibility of the Employee and Employer contributions for MA tax return.  And I believe what I found out is that since 2008, MA does not allow this deduction on Schedule X/Y.  Therefore, when the 401K distributes during retirement, the cost basis will come into play since the orginal contributions were not pre-tax deductions on the MA return.

I have "CHEERED all of you for replying to my question!

THANK YOU SO MUCH FOR ALL OF YOUR HELP!

SW

[swongtax]

I found the IRS instruction for Schedule C, Line 19, which is very clear.  Proseries did not provide such a clear instruction, unfortunately, and that is how I made the initial mistake of reporting the Employer Contribution amount on Schedule C-Line19.  sigh......

SW-----------------------

Schedule C - Line 19

Enter your deduction for the contributions you made for the benefit of your
employees to a pension, profit-sharing,
or annuity plan (including SEP, SIMPLE, and SARSEP plans described in
Pub. 560). If the plan included you as a
self-employed person, enter the contributions made as an employer on your
behalf on Schedule 1 (Form 1040),
line 15, not on Schedule C.