What Qualifies as "Self Employment Income" for setting up SOLO401

Question

Hello All,

I am going to be talking to a couple of the "Pros/Vendors" for are so sharing of their time and knowledge here this week about setting up our Solo401k accounts, but thought this might be a good question to ask here too for others that are wondering the same thing.

Our situation is that there are 3 of us who currently use SDIRAs, but want to set up Solo401k accounts for the added benefits of 1) Larger yearly contributions 2) Simpler bookkeeping/taxes when using leverage inside of a retirement account 3) and the possible use of the 'loan feature' that is available in a Solo401k

Two of us are clearly self employed beyond a doubt.

The third person is not as clear. Here is her situation;

• Teacher by profession. Participates in her retirement plan at work. I believe this is a 403B
• She also has a 'side job' of refereeing sports games where she teaches - the pay for this does NOT have any taxes withheld and she is considered a 'contractor' for this. Varies from $200 per year to maybe $600 per year.
• She coaches sports where she teaches - the pay for this DOES have taxes withheld and is added to her normal paycheck. A few thousand per year for this
• She helps her husband with the 'office work' for his Realty Business where he is clearly self employed.  He is a self employed agent. Although he does not pay her a 'paycheck' for this work, he would if it would help her be eligible for self employed status.
• They as a couple also own about 10 rentals properties, of which she does the majority of the paperwork. They hold these properties in their own name, not an LLC. Does this count towards self employment at all being that it is a 'passive income business'

Her goal is almost solely to be able to qualify for a Solo401K and roll her EXISTING sizeable Traditional IRA onto it, compared to making yearly contributions. Between her refereeing and being involved as a spouse in her husbands business, is that enough to make this work?

Thanks, Dan Dietz

Brian Eastman · Answer

@Bryan Otteson pretty well summed up this particular situation.

A Solo 401(k) is an "employer sponsored qualified retirement plan".  As such, there has to be an employer.  Such an employer can be a sole proprietorship, LLC, Corp, etc., but it must be generating earned income.

n a pass-through environment, this would be income reported on a schedule C (not a schedule E such as rentals).  W-2 wage income from a corporation also works.  Generally speaking, if you are providing a product or a service, it is earned income and would qualify.  If your "business" is generating passive income such as rentals, interest or dividends, then no, that is not self-employment income capable of sponsoring a Solo 401(k)

Of course, the Solo 401(k), which makes a great self-directed investing vehicle, is only eligible to owner-only businesses with no full time employees working more than 1,000 hours per year.

An individual may participate in more than one 401(k) plan.  Their contributions as an employee are set to one limit of $18K for those under age 50 and $24K for those 50 & older.  This can be made to one or more plans, however.  Employer contributions such as matches or profit shares are independent of each other.

As an employer qualified plan, a Solo 401(k) should be established when the business has the potential and inclination to make contributions to the plan.  If you setup a Solo 401(k), you should plan on making contributions at least periodically.  Setting a plan up and just rolling over other funds is not appropriate.  A Solo 401(k) also requires the ongoing viability of the employer.  If the employer goes out of business, the plan needs to be either terminated and rolled over to an IRA or a new employer needs to take over the plan.  I include this last bit of information because we encounter a whole lot of folks who think the Solo 401(K) is just "an account" and a means to invest their money.  Establishing a Solo 401(k) involves a good bit more than that, and requires a thorough analysis of your current situation as well as future operating plans.

Bryan O. · Answer

Hi @Daniel Dietz. In this case, the side gig of refereeing would be active income. The Realty Business work would be active income as well. None of the rental income would qualify to allow her to contribute to the 401k.

@john thedford, a person with a normal W-2 job with a retirement plan can still have a solo401k. They will have to be more cognizant of the contribution limits, but are not prevented from having or contributing to the soloK.

@Dmitriy Fomichenko, and @Brian Eastman are geniuses, so hopefully they'll stop in and say a few words.

John Thedford · Answer

@Brian Eastman may be able to help.

Justin Windham · Answer

@Daniel Dietz The third person in your post would be self-employed as a sports coach where she does not have taxes withheld and is considered a contractor. This does qualify her for a Solo 401k. She would then be able to roll her traditional IRA into the Solo 401k and have access to the benefits you described earlier in your post, among others.

@John Thedford You can contribute to more than one retirement plan. A common consideration when doing so is just how much you contribute to each plan as these contributions often need to be aggregated. This will vary depending on what type of accounts you have as well as other factors, but many people have more one retirement account.

Brian Eastman · Answer

@John Thedford

As an individual, you have a single cap of $24K that you can make across all 401k plans you participate in.

If you have your own Solo 401k and also participate in a separate employers 401k, the employer contributions will be independent.

If, however, you control multiple businesses, it gets complicated, and the ability of the employer(s) to make contribution may be linked across businesses.

John Thedford · Answer

@Mark Nolan

Both entities have NOI. One is substantially higher than the other. I max out the one with 24K contributions each year. What about a Roth? I do have a Roth but my understanding is that I can only contribute 6K per year. I would love to be able to convert that to a self directed Roth but don't know if that is possible. I do have an in plan Roth feature with the SOLO 401K but have not learned enough about it.

Mark Nolan · Answer

@John Thedford

Good question. Technically one can have multiple solo 401k plans but it does not make since because of the following:

When a self-employed individual maintains more than one trade or business, the question

arises as to whether the limit is based on the sum of earned income or loss from all trades or

businesses under common control [as defined in IRC 414( c)) as modified by IRC 415(h)], or if

only the trade or business maintaining the plan being tested is used.For purposes of the IRC 415

limit, earned income for the self-employed individual is based on the sum of the earned income

from all the controlled trades or businesses, regardless of whether the related employer maintains

a qualified plan [Reg. 1.415-2(d)(6)].

EXAMPLE: Andy, a sole proprietor, operates a law practice as a sole proprietor

and has $100,000 of self-employment income from such practice for 2008 (prior to

the reduction for one-half of self-employment tax). Andy also operates another

business that incurred a loss of $90,000 in 2008. Andy renders personal services in

operating both businesses, but only the law firm has adopted the qualified plan.

How is Andy’s IRC 415 limit calculated for the law practice’s qualified plan?

Andy’s IRC 415 limit is based on 20% of the combined income of $10,000

($100,000 – $90,000), less the ½ self-employment (SE) tax.

John Thedford · Answer

@Brian Eastman

So, if I contribute the max (24K) to my current solo I could not have another solo with a different entity I own and contribute to that as well?

Chris Frazer · Answer

Avid Kaufman @ Broad Financial.

Mark Nolan · Answer

The following IRS website covers the self-employment rules.

https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center

Also see IRS Publication 560 as it contains a whole section on self-employment for solo 401k qualification purposes.

https://www.irs.gov/uac/about-publication-560

What Qualifies as "Self Employment Income" for setting up SOLO401

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