How to handle overcontributing to Solo 401K?

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serbeer
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How to handle overcontributing to Solo 401K?

Post by serbeer » Thu Feb 09, 2017 12:40 pm

Folks,
I am wondering how to handle overcontributing Profit Sharing contribution portion of Solo 401K?

Basic facts:
My wife is W-2 emploee that contributes full $18K into her 401K plan at work. But she is also running solo proprietorship business part time that gives us some extra income. I opened Solo 401K plan for her with Fidelity, and am officially a plan manager on it. Obviously, since she is maxed out on her $18K employee portion at her plan at work (she gets emloyer match there), only Profit Sharing portion is contributed into this Solo 401K. It basically comes to ~19.732% of her business profits after following IRS instructions to calculate.

So, since the contribution can only be made while still in 2016, I had to take my best guess as to what final income for the year was, and had reasons to believe that I got it right. Well, now that we got 1099-MISC form, it looks like we overestimated the income by several thousands, and overcontributed as Profit Share by 19.732% of that overesatimate. The overcontribution amount is about $1K.

So, I am wondering what my options are now, is there a way to back-out/withdraw the overcontribution portion from Fidelity? It was invested too, so there would be some profit loss, and how would I be able to figure out what it is given that there are multiple ETFs that were purchased, and they all had different ROR...

Or does it simply mean that when I plug all the numbers into TurboTax, it will detect the overestimate amount, and add it to taxable income, so that we get to pay tax on it this year, and pay tax on it the second time when we withdraw the contributions years down the road (so it would effectively result in penalty of 2nd tax payment at the tax rate we would be at withdrawal time some years down the road)?

I am kind of lost here. Any opinions/advice please?

DTSC
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Re: How to handle overcontributing to Solo 401K?

Post by DTSC » Thu Feb 09, 2017 12:46 pm

I did this same thing. I just called up Fidelity and they helped me through it.

Basically, you have to ask them to calculate the excess amount and also the associated losses/gains since you made the contribution. You then have to send them a letter requesting that they made a distribution. The letter has some special wording (I can PM you my copy). They will then send you a check for that amount.

Spirit Rider
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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Thu Feb 09, 2017 1:32 pm

OP. you should avoid using the percentage of maximum employer contribution to the net business profit. It can vary and has no meaning beyond a specific set of circumstances of W-2 box 3 Social Security Wages and net business profit. Your employer contribution is always 20% of (net business profit - 1/2 SE tax).

There are two different procedures for a Solo 401k depending on whether you have an excess employee deferral or an excess employer 401k contribution.

An excess deferral is relatively easy to correct. You simply request a return of the excess deferral and earnings. Then make the the appropriate entries on your Form 1040. You do not claim the excess deferral as a deduction on line 28 and you must include any earnings on line 21 "other" income.

On the other hand, there is normally NO way to remove an excess employer contribution. There is an exception rarely granted for a mistake of fact, but this error almost certainly would not qualify for that.

The procedure for this is a little more complicated. You can only claim the allowed amount as a deduction on your Form 1040 line 28. Then you must complete Form 5330 including Schedule A for the excess amount and pay a 10% excise tax. Note: This is not included in your personal return. This is being filed and paid for by the employer and submitted separately to the address specified.

The excess amount is carried forward into next year and you should reduce the amount contributed next year by this amount. You will file a second 5330 next year reconciling this. There will be no excise tax or filing needed unless you do this again. I do not know if TurboTax will properly handle this overall situation.

P.S. This statement; "So, since the contribution can only be made while still in 2016." was incorrect.

The Solo 401k account must be opened and the employee deferral election must be completed by 12/31. A sole proprietor has until their tax filing deadline (4/18/17) including extensions (10/16/17) to make both the employee deferral and the employer contribution.

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BolderBoy
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Re: How to handle overcontributing to Solo 401K?

Post by BolderBoy » Thu Feb 09, 2017 2:31 pm

serbeer wrote:So, since the contribution can only be made while still in 2016
The profit sharing (employER contribution) can be made beyond the tax year in which it applies. Very common for companies to wait until January of the following year to make the final contribution so that all the dust has settled and they get the $$$$ amount right.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

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serbeer
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Re: How to handle overcontributing to Solo 401K?

Post by serbeer » Thu Feb 09, 2017 5:03 pm

Well, thank you folks, this really helps. I will know for the future that I can wait till I get 1099-MISC form in the next year to finish up on Profit Share contribution!

DTSC,
thank you for the tip, I'll call Fidelity and see if they are equally accomodating with my situation. Yes, I'd appreciate if you PM me the letter, after removing all personal info from it of course. Did you also overcontribute profit sharing in 2016 and this is still work in progress to reverse? Or was it one of previous years, so you've gone though the process fully already? Did you have to fill out Form 5330 as per SpiritRider's response?

Spirit Rider,
the percentage is just end result of calculations, I use https://thefinancebuff.com/solo-401k-fo ... yment.html caclulator for that.
As far as "there is normally NO way to remove an excess employer contribution" that seem to contradict DTSC's experience, so I'll see if Fidelity can help with that. I'll have to read-up on this 5330 form, never heard of it before. Does it make any difference that this is Solo Proprietorship, so my wife is also the employer, and Profit Sharing contribution is by herself?

DTSC
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Re: How to handle overcontributing to Solo 401K?

Post by DTSC » Thu Feb 09, 2017 5:32 pm

For some reason, the system won't let me send a PM - it remains stuck in the outbox. Anyway, the letter they instructed me to write looks something like this:

RE: PROFIT SHARING KEOGH ACCOUNT XXXXX



Fidelity Investments
Attn: Retirement Distributions
PO Box 770001
Cincinnati, OH 45277-0035

January 21, 2017

Dear Sir or Madam:

I am requesting a corrective distribution of an excess employee deferral for tax year 2016 due to IRC 402(g) and under EPCRS guidelines. The excess deferral was made on (dates) in the amount of $X. Earnings in 2016 was $Y and therefore I am requesting a total distribution of $(X+Y) to be mailed to me, without any tax withholding.

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Duckie
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Re: How to handle overcontributing to Solo 401K?

Post by Duckie » Thu Feb 09, 2017 6:15 pm

DTSC wrote:For some reason, the system won't let me send a PM - it remains stuck in the outbox.
Messages you send stay in the Outbox folder until the recipient reads them. Then they go into the Sent messages folder. A message still in the Outbox folder may be edited or deleted.

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Thu Feb 09, 2017 6:39 pm

serbeer wrote:As far as "there is normally NO way to remove an excess employer contribution" that seem to contradict DTSC's experience, so I'll see if Fidelity can help with that. I'll have to read-up on this 5330 form, never heard of it before. Does it make any difference that this is Solo Proprietorship, so my wife is also the employer, and Profit Sharing contribution is by herself?
If you see DTSC's followup post, it is reference to an excess employee deferral. This is a relatively common occurrence that happens to many people having two 401k plans in one year and not limiting their deferrals. This could be the reason for a Solo 401k excess deferral or simply a mistake.

You have an excess employer contribution that rarely happens in a regular job. Even if it does, it is the employer's responsibility. A Solo 401k is like an iceberg. It only requires a little more effort to set up than an IRA, but it is still first and foremost a 401k subject to the vast majority of the same laws and regulations as any other 401k.

It doesn't matter your wife is a sole proprietor. She is both the employee and the employer and as the employer is subject to the 5330 excise tax in this circumstance.

P.S. I really wish that one-participant 401k plan providers would make this particular piece of information exceptionally clear to you before you open the plan. They really should provide a fact sheet of the dos and don'ts. Instead it is more like showing up for your first driving lesson and being given the keys and told to take the car and don't crash it.

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serbeer
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Re: How to handle overcontributing to Solo 401K?

Post by serbeer » Thu Feb 09, 2017 7:32 pm

Thank you very much guys, that really helps.

And thank you Spirit Rider for my first advanced solo 401K driving lesson, yes, I am pretty rookie plan manager :)
So, if I understood you correctly, I should go ahead and send in 5330 at the same time I finish my 2016 tax return (because only then Schedule A will be available), right? And filing of this 5330 form is not going to be mentioned in any way on my 1040, so as far as 1040 is concerned, I simply pay income tax on anything beyond allowed profit-sharing deferal amount? Or is there some other time or cross-reference relation between 5330 and 1040 forms that you did not mention in your original response?
Also, is it correct that the earnings, if any, of such over-contribution are not subject to taxes on either 5330 or 1040 this year, just staying in account until withdrawal time, and then simply taxed as any other withdrawal from this Solo 401K, correct? I really hope so since as I said, it would be very hard to try and deduce what earnings this particular overcontribution resulted in, though it should not be much since the overcontribution was only applied to the account on Dec. 27.

Thank you!

Spirit Rider
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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Thu Feb 09, 2017 9:35 pm

There is no need send this in at the same time as your 1040. It should not be included with your personal 1040. This is a separate filing from the administrator of your 401k plan. The deadline for the schedule A section is 7/31. Form 5330 and the payment goes to its own special place:

Department of the Treasury
Internal Revenue Service Center
Ogden, UT 84201.

I should have it more clear. The schedule A I am referring to is not the Schedule A from you personal 1040. It is simply a section of the Form 5330. Why they call these schedules, I have no idea, on Form 5329 they call them Parts.

Yes, there is no actual interaction between your personal 1040 and the employer's 5330. The allowed deduction on Form 1040 line 28 will be the allowed maximum contribution. It isn't that your taxes are higher, but rather the correct amount. You are correct this has no effect on the earnings. They remain until withdrawn.

A helpful suggestion. You should be conservative with your employer contributions. You should contribute no more than 75% - 80% of actual net business profit - 1/2 SE tax during the year. If you were to make an excess contribution after January 1st, you can reallocate it to that year's contribution. However, most CPAs will not make the final contribution until the tax return has been completed. Some won't even make a single contribution until then.
Last edited by Spirit Rider on Thu Feb 09, 2017 9:45 pm, edited 1 time in total.

CFM300
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Re: How to handle overcontributing to Solo 401K?

Post by CFM300 » Thu Feb 09, 2017 9:44 pm

serbeer wrote:it looks like we overestimated the income by several thousands, and overcontributed as Profit Share by 19.732% of that overesatimate. The overcontribution amount is about $1K.
If the excess employer contribution is about $1K, then you overestimated her income by about $5K.

But are you sure that she didn't receive some additional income -- a cash payment, perhaps -- that should be included on her Schedule C such that your income estimate was correct and the employer contribution was accurate?

Or perhaps she could forgo some of her business expenses in order to bring her net SE income up $5K?

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Thu Feb 09, 2017 9:52 pm

CFM300 wrote:Or perhaps she could forgo some of her business expenses in order to bring her net SE income up $5K?
Really, forgoing $5,000+ in expenses to save a $100 excise tax (10% of $1,000). On what planet does that make sense.

Also, while you are perfectly free on your personal taxes to forgo a deduction, you are obligated to claim all legitimate expenses on your Schedule C.

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Re: How to handle overcontributing to Solo 401K?

Post by CFM300 » Thu Feb 09, 2017 10:09 pm

Spirit Rider wrote:
CFM300 wrote:Or perhaps she could forgo some of her business expenses in order to bring her net SE income up $5K?
Really, forgoing $5,000+ in expenses to save a $100 excise tax (10% of $1,000). On what planet does that make sense.
Correction: "to save $100 excise tax and the hassles of understanding additional tax laws and filing additional IRS forms, outside of your 1040, this year and next." I guess it depends on their marginal tax rate and how much additional they'll pay in taxes if an additional $5K of income materializes. But it will probably be several hundred more, at least, so you're right: dumb idea.
Spirit Rider wrote:Also, you are perfectly free on your personal taxes to forgo a deduction, but you are obligated to claim all legitimate expenses on your Schedule C.
I did not know that. Citation? I just scanned the instructions for Schedule C and see lots of "can deduct", but no "must deduct".

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Thu Feb 09, 2017 11:00 pm

The IRS has held in various circumstances that you can not manipulate your Schedule C expenses in order to obtain a taxable benefit. The one circumstance I remember had to do with artificially increasing your net business profit to increase an earned income credit. There are also other cases where increased income will be 100% offset by non-refundable credits.

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serbeer
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Re: How to handle overcontributing to Solo 401K?

Post by serbeer » Thu Feb 09, 2017 11:18 pm

Ah, so Schedule A of 5330 is not that of 1040. Got it. I think now it is all crystal clear.

Thank you to everyone who responded with helpful suggestions, and special thanks to Spirit Rider for his expertise and very detailed indeed driving lesson! Time to buckle up I guess :)

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serbeer
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Re: How to handle overcontributing to Solo 401K?

Post by serbeer » Fri Feb 10, 2017 6:13 pm

Spirit Rider,
I spent some time today going over Form 5330 and its instructions, and have pretty good understanding what I have to file this year, as "an employer liable for the tax under section 4972 for nondeductible contributions to qualified plans." However, nowhere have I found even mentioning of need for the 2nd year, "reconsiliation" form 5330 as you called it, the one that has to be submitted with no payment.

Can you elaborate on it a bit please? Why is it required?

Also, am I correct that Fidelity does not even need to be informed about any of this?
Thank you very much!

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Fri Feb 10, 2017 10:43 pm

The need to file for the next year is not explicitly stated on Form 5330 or the instructions. This is also true of Form 5329 which is used for IRA, HSA, etc.. excess contributions that are not removed and subject to the 6% excise tax.

However, it is a little clearer to infer the requirement on Form 5329, because they specifically ask what the excess balance is from the previous year. In contrast Form 5330 Schedule A line 4 is: "Enter amount of any prior year nondeductible contributions made for years beginning after 12/31/86."

If you understand the reason for Form 5329, you know the reason for Form 5330. When you file a Form 5329 reporting an excess contribution and paying the 6% excise tax, the IRS is recording that balance and it is carried forward subject to the excise tax every year unless the excess is removed. You then have to file a Form 5329 every year while that balance exists. The same is true of Form 5330.

So that is why you need to file the follow-up Form 5330. You need to show if some or all of the excess contributions have been allocated into the allowed employer contribution space for that year.

You are correct that none of this concerns Fidelity, the contribution and earnings stay in the Solo 401k. There is nothing they need to do or know about.

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serbeer
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Re: How to handle overcontributing to Solo 401K?

Post by serbeer » Fri Feb 10, 2017 11:13 pm

I see. Yes, I noticed the lines 4-7 in Schedule A, the only place that makes reference to previous years.

The Schedule is where most actions take place. Only single line is transfered to Part I of 5330 itself, line 1 in my case, and part II is just tax due amount. So, if I understand you correctly, the second year's 5030 line 1 will simply be 0, and tax due will be 0, while Schedule A will show that I counted previous year excess against 2017 year Profit Share amount limit.

Thank you for you help with that Spirit Rider.

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Re: How to handle overcontributing to Solo 401K?

Post by bogleinvester » Fri Mar 23, 2018 4:38 pm

serbeer I am in the same situation with excess employer contribution. I got good help from a discussion in this thread. Thanks!

I have few follow up questions if you can help.

Is it ok if I file this form before April 17, 2018? Instructions says
Reported by the last day of the 7th month after the end of the tax year
and am not sure if I understand deadline dates.

For tax year 2017 (schedule A, section 4972)
What is line 1 amount? Is it total 401K contribution (employee + employer) or just employer contribution amount?
What is line 2 amount? Is it total Max 401K contribution (employee + employer) or just max employer contribution amount?

Do I withdraw excess employer contribution or let it sit there and ask Fidelity to carry over for 2018?

If I file form 5330 for 2017, then I also file 5330 for 2018. Is that correct?
For tax year 2018 (schedule A, section 4972)
For line 1 and line 2 for the following year, do we include the excess amount of 2017?
For line 4 and line 5, I use excess amount from 2017. line 6 and line 7 will be 0. And total tax dues will be 0, right?

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Re: How to handle overcontributing to Solo 401K?

Post by Lafder » Sat Mar 24, 2018 4:56 pm

I thought that employer and employee contributions can be made until the tax filing deadline for a solo401k? They must be set up in the tax year, but once established you have the extra time in the next year and you can wait to see what your tax return tells you is the max contribution. I routinely wait til my accountant has my return ready, I tell her to max the contribution. Then I send the contribution she tells me to before we file the return.

lafder

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Sat Mar 24, 2018 7:46 pm

bogleinvester wrote:
Fri Mar 23, 2018 4:38 pm
Do I withdraw excess employer contribution or let it sit there and ask Fidelity to carry over for 2018?
You can not withdraw excess employer contributions. This is the reason for the whole effort. It and the earnings remain in the account. This has nothing to do with Fidelity. There is nothing for them to do. The 1st Form 5530, excise tax, carryover of the excess employer contribution, 2nd Form 5530 and reconciliation with the next years employer contribution space is solely between you and the IRS.

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Re: How to handle overcontributing to Solo 401K?

Post by alexDDS » Sun Mar 25, 2018 2:59 pm

How to treat corrective distributions for self-employed with no W-2 ?As a (business expense)employer contribution and then issue 1099-R to yourself? or just as a draw and disregard it because its not a taxable income?
Plan administrator disbursed excessive deferrals and moved Safe Harbor excess to forfeiture account before March 15, but it looks like I have 6$ gain for deferrals and $3.50 for SH not distributed before March 15th. Am I in trouble? Do I need to file form 5530? Thank you.

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Sun Mar 25, 2018 6:53 pm

alexDDS wrote:
Sun Mar 25, 2018 2:59 pm
How to treat corrective distributions for self-employed with no W-2 ?As a (business expense)employer contribution and then issue 1099-R to yourself? or just as a draw and disregard it because its not a taxable income?
Plan administrator disbursed excessive deferrals and moved Safe Harbor excess to forfeiture account before March 15, but it looks like I have 6$ gain for deferrals and $3.50 for SH not distributed before March 15th. Am I in trouble? Do I need to file form 5530? Thank you.
An individual does not issue a 1099-R. If this is a Safe Harbor 401k plan with employees. The SH issue this is beyond my level of knowledge or almost all BH forum members. You need to contact your plan administrator and/or a professional retirement plan specialist. This is not likely something you can or should get answered in an online forum. Even if such a professional were to respond it is unlikely they would give you such complex advice here.

The excess employee deferral is a standard issue resolved on your personal W-2 and/or tax return. See IRS publication 560.

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Re: How to handle overcontributing to Solo 401K?

Post by alexDDS » Sun Mar 25, 2018 8:27 pm

Thank you.

bogleinvester
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Re: How to handle overcontributing to Solo 401K?

Post by bogleinvester » Sun Mar 25, 2018 11:07 pm

Thanks a lot, Spirit Rider!

Can you please confirm the amounts to be used for Form 5330/Schedule A for 2017 and 2018?

For 2017, is 410 K contribution amount on Form 5330/Schedule A/Line 1 & 2 include an employer+employee contribution or just employer contribution?

Thanks

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Re: How to handle overcontributing to Solo 401K?

Post by iudaea » Mon Apr 02, 2018 1:18 pm

Thanks for all your help on this thread. You guys are great. You can't get this kind of advice anywhere else. I made the same mistake as the OP and others, thanks for walking all of us through it Spirit Rider! I went from feeling "oh crap" to thinking "I was stupid, but I can make it right."

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Re: How to handle overcontributing to Solo 401K?

Post by Spirit Rider » Mon Apr 02, 2018 7:32 pm

This is a really insidious problem unique to one-participant 401k employer contributions. This is true for all 401k plans, but with regular employment it is someone else's problem.

Excess employee elective contributions > (2017 = $18K), excess employee elective contribution due to ADP testing failures and tIRA/rIRA/HSA excess contributions are all relatively well known with easy correction processes.

There are probably a thousand websites extolling the virtues of one-participant 401k plans. I have yet to see one caution about this when describing the maximum contribution. I am not familiar with any provider providing a caution about this. I have suggested having this added to the Wiki. Even the IRS doesn't mention this on their one-participant 401k web page.

The only public facing place I have seen this described is in IRS Publication 560 Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans). Even there you have to know what your looking for. Not many people are going to read the entire section on qualified plans. I know I haven't done it myself.

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