Solo 401ks continue to grow in popularity and are the preferred option for many self-employed folks. Unfortunately, we find that many plans have not been properly maintained and face the risk of significant penalties and even worse – plan termination.
Ensuring that your plan is properly maintained and updated is not that difficult, but it does require some attention so that you do not get into trouble. Here are a few of the most significant issues that we see when it comes to plan maintenance and compliance.
1) Does The Plan Need to File Form 5500?
There are two main circumstances that a solo 401k plan may be required to file Form 5500. First, if the plan has over $250,000 in assets. Second, when the plan is terminated.
Should either of these situations occur, the plan must file Form 5500 with the IRS. For a calendar year plan, Form 5500 is due by July 31 for the prior year plan activity. Solo 401ks have the ability to file what is called a 5500-EZ. This form is a shortened and streamlined version of the standard Form 5500.
Unfortunately, Form 5500-EZ cannot be filed electronically and must be filed by mail. Solo 401k plans have the option of filing Form 5500-SF on-line through the Department of Labor. On-line filing is typically preferred as it can be tracked by the plan sponsor.
In fact, if a plan qualifies to file a 5500-EZ, the IRS and DOL allow you file the Form 5500-SF on-line but you are allowed to skip certain questions and sections so that you only answer what is required on Form 5500-EZ.
2) Have Funds Been Properly Tracked?
All solo 401k funds must be properly tracked and must identify the different sources of funds for each plan participant. As an example, if two spouses are each making Roth and traditional 401k contributions then these funds need to be tracked separately, including the investment earnings for each type of contribution.
3) Funds Must Be Separated by Source and Participant.
Separate bank accounts should be established for the different participant funds. This would include spouse or even partners in a partnership. Additionally, you must document investments from any fund source so that investment returns to the plan are properly credited to the right account.
4) Are Contributions and Rollovers Being Properly Reported?
If funds have been rolled over from an IRA or other 401k to your solo 401k, you were required to indicate that the rollover was to another retirement account. Assuming this was completed, the company rolling over the funds will issue a 1099-R to you (the plan participant), but will include the proper code on the 1099-R (code G in box 7) that indicates that the funds were rolled over into another retirement account and is not subject to taxation.
When you make new contributions to the plan, those contributions would be reflected on your personal and business tax returns. If you’re an S-Corporation, your employee contributions are reflected in box 12 on your W-2 and any employer contributions will be on line 17 of your 1120-S tax return. Should you be a sole proprietor, your contributions will generally show up on your personal 1040 tax return on line 28.
5) Has the Plan Been Updated for Changes in the Law?
The IRS requirement is that all 401k plans (which includes solo plans) should be amended at least once every 6 years. If your plan has been in existence for over 6 years and you’ve never completed a plan amendment or restatement, it is likely not in compliance. If ever audited you could be subject to fines and possible plan revocation.
Should your plan need updating, make sure you restate the plan and adopt any new provisions that allow it to be compliant. Most plan documents will need to be updated at least every couple years to reflect current laws.
The above rules and requirements must be reviewed on an annual basis. If you believe you have a compliance issue, make sure to contact your Third Party Administrator (TPA) or an attorney to ensure it is compliant. If you determine that you failed to file Form 5500, penalties are $25 a day up to a maximum penalty of $15,000 per return. That is rather steep for a relatively simple filing requirement.
Fortunately, there are correction programs offered for certain plan failures. Just make sure to get it resolved or you risk plan termination and a substantial tax problem.