If you have a business that is organized as an S-corporation (S-corp) and owned by one or more partner(s), or shareholders, you can set up a Self-Directed Solo 401(k) plan for your business, assuming all other eligibility requirements are met.
First, let’s confirm that an S-corp can sponsor this kind of plan. By definition, a Self-Directed Solo 401(k) plan is a 401(k) for owner-only businesses with no full-time w-2 employees working more than 1,000 hours per year, (other than the owner(s) or his/her spouse). Per the IRS website for one participant plans, the IRS provides an example scenario involving a Solo 401(k) sponsored by an S-corp in order to explain the salary deferral and profit-sharing contribution limits. Therefore, it can be deduced that the IRS acknowledges that an S-corp can sponsor a Solo 401(k) plan.
Second, let’s look at how it works when more than one person owns the company. For an S-corp with multiple partners/owners, each partner must own more than 2% of the outstanding stock of the S-corp, (see IRC Section 1372). Therefore, an S-corp can open a Solo 401(k) plan as long as each of the partners own more than 2% of the outstanding shares of the S-corp and they do not employee full-time w-2 employees.
The company would sponsor one plan and each partner would have his/her own account, (or accounts, if they contribute in more than one of the following ways: pretax, Roth, after-tax,) that will roll up under the plan.
Each partner can contribute to his/her own account(s) through elective salary deferral and profit-sharing. Since they are an S-corp and pay themselves a salary, the contribution calculations are based on their salary. The contribution limit is stated as: up to 100% of salary from self-employment, not to exceed the following limits for 2020: $19,500 for salary deferral and 25% of his/her salary for profit sharing. The combined annual limit for both is $57,000, for those under 50 years of age. For those who are 50 or older, there is a salary-deferral catch-up contribution of $6,500 that can also be included, bringing the limit to $63,500. (The profit of the company has no bearing on the calculation.)
The salary deferral portion must be paid as the salary is earned and is generally contributed through payroll. It also needs to be contributed within a “reasonable period of time” after the salary has been earned, but no more than 7 days later. The profit-sharing portion can be contributed up until the tax filing deadline, plus extension.
Since the calculation is based on each partner’s salary, instead of paying themselves a lower salary to reduce their tax liability, they may consider paying themselves a higher salary to maximize their contributions, which still helps to reduce their tax liability. (A CPA, or tax professional, should be consulted to help determine the amounts that make the most sense for you and your overall financial situation and goals.)
The amount, or tax status, of the contributions that one partner makes to his/her account has no bearing on what or how another partner can or cannot contribute to his/her own account, and they each have their own limit of $57,000/$63,500. If a partner’s spouse earns income from the business, he/she can also have an account and contribute to it separately.
Keep in mind, Form 5500-SF or 5500-EZ will need to be filed annually if the PLAN’s total value is $250,000 or more by 12/31. This amount could be reached quickly if there are multiple accounts under the plan. More information about the Forms can be found here, and information about calculating the value of the plan’s assets can be found here.
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