Fix overcontribution to non-deductible portion Solo401k plan

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DavidRoseMountain
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Joined: Sun Nov 30, 2014 3:27 pm

Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Mon Mar 12, 2018 7:30 am

I need to fix an over-contribution I made as an employee to the non-deductible account of the Solo401k plan that I have for my Schedule C sole proprietor business. I did this in 2017 for 2017 tax year and I have not yet filed my 2017 return.

Here’s the link to the original post I wrote asking what was the maximum after-tax (non-deductible) contributions I could make to my individual 401k plan.
viewtopic.php?f=2&t=228427&p=3548679#p3547279

In November, 2017 I (unknowingly) over-contributed to my after-tax account in my Fidelity non-prototype account. Within days I rolled that over into another account designated as my Roth 401k account. This is an employee voluntary after-tax or non-deductible contribution.
In January 2018 I already issued a 1099-R to the IRS for this rollover from the after tax to the Roth 401k account.
The amount I contributed was 12,000 but apparently based on new information I should have only contributed a maximum of 8,155
On an aside I had approx. 5,000 in wage income from a part time job where I received a W-2.
I have some passive interest and dividend income but it isn’t large, and won’t affect calculating 401k deductions.

My 2017 business income is 57,667 and I have an individual 401k Plan associated with it, and I used Fidelity as the holder of the non-prototype plan accounts for this 401k.
Net Business Profit – 57,667
Deductible Self-employment tax – - 4,074
Adjusted Net Business Profit - - 53,593
Maximum Profit Sharing - -10,719
Employee Compensation 42,874

Apparently the test for determining 2017 maximum I can contribute to the 401k plan including after-tax contributions is the lesser of 54,000 or employee compensation of 42,874

That 42,874 is what I can fill the space up with for all contributions:
1. 24,000 in employee salary deferral (includes the 6,000 for over age 50)
2. 10,719 in employer profit sharing
3. 8,155 in employee after tax voluntary contributions

Any suggestions on how to unwind a portion of the 12,000 I contributed to the Fidelity account, to make it only $8,156?

How do I make a corrected 1099-R?
My 1099-R did show $1 in taxable gains before I was able to roll it over from the after-tax account to the 401kRoth account - Fidelity.
Line 1: 12,001
Line 2a: 1
Line 5: 12,000
Line 7: Code G

What do I need to give to IRS for 2017 tax return to correct these mistakes?

Spirit Rider
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by Spirit Rider » Mon Mar 12, 2018 12:08 pm

Congratulations on catching this and a mea culpa is in order from tfb and myself for not catching this in your other thread. We were mistakenly fixated on the self-employed health insurance deduction. I have been cautious to recommend people "roll-their-own" one-participant 401k for the so-called Mega Backdoor Roth. However, it seems like you have the attention to detail, quest for information and the motivation to "get it right".

While you figured out that the Deduction Worksheet for Self-Employed in IRS Publication 560 Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) only applies to employer contributions. Steps 9-13 are illustrative of the fact that employer contributions reduce compensation. The 415c annual addition limit is the lower of the statutory limit (2017 = $54K ), 2018 = $55K) and 100% of compensation after reducing for employer contributions.

I would venture to guess that the majority of one-participant 401k sponsors are not aware a self-employed individual's compensation is reduced by employer contributions. I would further suggest that it is likely that many sponsors of roll-your-own 401k plans doing Mega Backdoor Roths are similarly exceeding the 100% of compensation 415c limit.

This is a "Failure to satisfy the defined contribution annual additions limit." 401k plan error. This must be corrected under the IRS Employee Plans Compliance Resolution System (EPCRS). Luckily, I believe this qualifies as an insignificant operational error and is eligible for the Self-Correction Program (SCP) without contacting the IRS or paying a fee. The correction is quoted below.

"For excess annual additions that are elective deferrals or employee after-tax contributions, the plan must distribute the respective elective deferrals or employee after-tax contributions with allocable income."

I am not 100% sure of the following. Maybe Alan S. will reply.

There is nothing required for the 401k, because all after-tax contributions and earnngs including the excess annual addition have already been distributed. I believe the 1099-R is still correct, because that is the amount rolled over from the 401k. Was this done in and reported for 2017? If so, you would still report $12,001 on your 2017 Form 1040 Line 16a and $1 in Line 16b.

However, the excess annual addition is now in your Roth IRA. You will need to request the removal of the excess annual addition and earnings from the Roth IRA. You will receive a 1099-R from the Roth IRA custodian next year and report it on your 2019 tax return.

You should document the correction steps you took and what you will do to insure this will not happen again. Then just place the letter in your one-participant 401k file. That should be the end of it. Not so bad after all.
Last edited by Spirit Rider on Mon Mar 12, 2018 12:29 pm, edited 1 time in total.

DavidRoseMountain
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Mon Mar 12, 2018 12:29 pm

Thank you spirit rider. I can't really take credit for paying attention to detail vis a vis the correct after tax contribution. The person who alerted me to my dumb mistake goes to "Avi" on thefinancebluff's blog.
I'm just feeling ashamed and embarassed.
Yes the 1099-R was done and reported for 2017, and the IRS received it and accepted it.
Yes the excess annual addition is now in the 401k Roth account.
So if I remove the excess annual addition and earnings, I would take a percentage of (12001-8155)/8155, and the gain above 8,155 would be taxable I assume? Not sure if it's ordinary income. I guess it would be.

Spirit Rider
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by Spirit Rider » Mon Mar 12, 2018 12:50 pm

I missed the fact that you did an IRR to the designated Roth account instead of to a Roth IRA. It should just change where the distribution comes from.

Usually, the trustee does this so I have no direct knowledge. I would think that the excess annual addition earnings would be proportional to the entire earnings. I would think it would be (12000-8155)/8155 * total earnings (including the $1).

Here again, I hope Alan S. or someone who has done this would drop by and reply.

DavidRoseMountain
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Mon Mar 12, 2018 1:06 pm

I see IRS websites that relate to this issue.

https://www.irs.gov/retirement-plans/fi ... articipant

https://www.irs.gov/retirement-plans/co ... escription

https://www.irs.gov/retirement-plans/re ... correction

This is the passage on the first link above that seems to most relate to my mistake:

Fixing the Mistake:
If contributions for a participant include both employer and employee elective contributions, exceed IRC Section 415(c), correct in the following manner:
Step 1: Distribute unmatched elective contributions (adjusted for earnings) to the affected participant. If any excess remains, then proceed to Step 2.
Step 2: Distribute elective contributions (adjusted for earnings) that are matched, and forfeit related matching contributions (adjusted for earnings). If any excess remains, then proceed to Step 3.
Step 3: Forfeit other profit-sharing contributions.
The employer should report the corrective distribution made to the participant on Form 1099-R. The participant should include the distribution as income but does not have to pay the 10% additional tax on early distributions under §72(t) of the Code. In addition, the participant may not rollover the corrective distribution to another qualified plan or to an IRA.
The plan sponsor should transfer the forfeited employer contributions (profit-sharing or matching) to an unallocated account. These amounts are used to reduce employer contributions in the current year and, if applicable, subsequent year(s).

Wow it looks like I have to guess as to whether the error is insignificant or not, and moreover, if the IRS isn't happy with the correction, then I can lose the 401k deductibility altogether. This seems kind of frightening.

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tfb
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by tfb » Mon Mar 12, 2018 1:44 pm

Spirit Rider wrote:
Mon Mar 12, 2018 12:08 pm
Congratulations on catching this and a mea culpa is in order from tfb and myself for not catching this in your other thread. We were mistakenly fixated on the self-employed health insurance deduction. I have been cautious to recommend people "roll-their-own" one-participant 401k for the so-called Mega Backdoor Roth.
Indeed, and I regret showing this path as possibility. There are just too many opportunities to mess up.

David - Before you actually do something, please double-check and triple-check to make sure you really have the right numbers this time. I was wrong once. I could be wrong twice. If you must fix, you want to fix it right. Maybe you got "lucky" because you had a catchup that doesn't count toward the compensation limit.
Harry Sit, taking a break from the forums.

Spirit Rider
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by Spirit Rider » Mon Mar 12, 2018 2:28 pm

tfb wrote:
Mon Mar 12, 2018 1:44 pm
David - Before you actually do something, please double-check and triple-check to make sure you really have the right numbers this time. I was wrong once. I could be wrong twice. If you must fix, you want to fix it right. Maybe you got "lucky" because you had a catchup that doesn't count toward the compensation limit.
tfb is absolutely correct! Ahhh, I missed two in a row.

The $6,000 catch-up contribution is not included in the annual addition limit. This applies to both the 415c 2017 $54K statutory limit and the 100% of compensation limit.

From your numbers, your maximum after-tax contribution should be:
  1. $57,667 Net Business Profit
    $ 4,074 Deductible Self-employment tax
    $53,593 Adjusted Net Business Profit
    --------------------------------------------------
    $10,719 Maximum Profit Sharing
    $42,874 Employee Compensation
    --------------------------------------------------
    $18,000 Employee salary deferral ($6,000 >= age 50 is not included in the 415c limit)
    $10,719 Employer profit sharing
    $14,155 Employee after tax voluntary contributions
tfb is right you should double check, triple check these numbers, but certainly looks like you do not have an excess annual addition.

I have got to stop focusing on the remedy and focus on the big picture. My remedy was probably correct, but irrelevant.

DavidRoseMountain
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Mon Mar 12, 2018 4:22 pm

I've quadruple checked my business income numbers. I know with 100% certainty about my Schedule C income.
I know with 100% certainty what my salary deferral is, and exactly how much I already contributed as after tax voluntary employee contribution I made in November 2017 is.

I really appreciate the time you took out to look this over.

Sorry I didn't respond sooner, been busy with work. Now I'm off to go teach yoga.

I'll respond more.

Truly thanks,
David

DavidRoseMountain
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Mon Mar 12, 2018 10:52 pm

Thank you Spirit Rider for doing that math. And thanks Harry for looking at this too. Also, Harry did you do something new to the spreadsheet, because now it works exactly as Spirit Rider's math reveals.

It does look like I'm ok and I haven't over-contributed.

I know my numbers are correct. My tax return is done and just waiting for me to finish contributing the last little bit to the employer portion (already contributed $8,000 for that). My CPA who does my taxes does a good job, he happens to be my brother, and taxes are his specialty. He's more used to dealing with wealthier Wall street type people. My brother thinks its weird that I do an individual 401k plan, and he believes hardly anyone does this.

Thanks again Spirit Rider and Harry.

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tfb
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by tfb » Tue Mar 13, 2018 12:05 am

DavidRoseMountain wrote:
Mon Mar 12, 2018 10:52 pm
Also, Harry did you do something new to the spreadsheet, because now it works exactly as Spirit Rider's math reveals.
I tried to make it calculate correctly, although I still can't guarantee it does for every case.
Harry Sit, taking a break from the forums.

DavidRoseMountain
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Re: Fix overcontribution to non-deductible portion Solo401k plan

Post by DavidRoseMountain » Tue Mar 13, 2018 12:59 pm

Well I appreciate what you do.

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