The calendar might say 2021, but some small businesses can still set up a Solo 401k and make contributions to reduce their 2020 tax bill. This is possible if you filed an extension for your tax return. Extension requests are due by the federal tax return due date. Sole proprietors and single-owner LLCs, who normally have to file their tax return by April 15, had until May 17, 2021 to file their 2020 taxes. Winter storm disaster relief granted more time for Louisiana, Oklahoma, and Texas tax payers as well. These states had until June 15, 2021 to file individual and business tax returns. If your business is an S corporation or a partnership, the return was due on March 15, 2021. (All dates apply to federal income tax returns only.)
Qualifying for 2020 Tax Extensions
Sole proprietors and single member LLCs (almost all Solo 401k LLCs are single member) use IRS Form 4868 to file for an extension. Businesses with this extension have until October 15, 2021 to file taxes and have until that date to set up a Solo 401k and make contributions to reduce their 2020 tax bill.
Most S corporations, partnerships, and multi-member LLCs use IRS Form 7004 to file for an extension. Businesses with this extension have until September 15, 2021 to file taxes and still set up a Solo 401k and make contributions to reduce their 2020 tax bill.
There is some flexibility on extension form type depending on your business structure. The chart shows possible options for S corporations, partnerships, and multi-member LLCs. If you use IRS Form 4868, the extension date is October 15, 2021 to file taxes and still set up a Solo 401k and make contributions to reduce the 2020 tax bill.
More on Extensions
You can also get an extension by paying all or part of your estimated income tax due. Then, you can indicate the payment is for an extension. Options are Direct Pay, the Electronic Federal Tax Payment System (EFTPS), or a credit or debit card. This way you won’t have to file a separate extension form and you will receive a confirmation number for your records.
You will not receive confirmation that your extension has been approved – from IRS Instructions for Form 7004:
“Properly filing Form 7004 will automatically give you the maximum extension allowed from the due date of your return to file the return. The IRS will no longer send a notification that your extension has been approved. We will notify you only if your request for an extension is disallowed.”
The instructions for Form 4868 state:
“You’ll receive an electronic acknowledgment once you complete the transaction.”
The extension was probably approved if you filed, and were expecting confirmation, but did not receive one. You can still open and fund a Solo 401k.
What This Means for Setting Up Your Solo 401k
“This continues to be a tough time for many people, and the IRS wants to continue to do everything possible to help taxpayers navigate the unusual circumstances related to the pandemic, while also working on important tax administration responsibilities,”
~IRS Commissioner Chuck Rettig
Owner-only business tax return filing deadlines generally drive Solo 401k contributions. If you have filed an extension for the year 2020 taxes, you have until the end of the extension period to, also, open and fund your Solo 401k account.
Sole Proprietors:
Employee Deferral
- Sole proprietorship owner may make employee deferral contributions up to $19,500 to a Solo 401k plan for 2020.
- Those who are 50 and older can tack on an additional annual catch-up contribution of $6,500, bringing their annual deferral contribution up to $26,000.
- According to Solo 401k contribution deadline rules, plan participants must formally elect to make an employee deferral contribution by Dec. 31. However, the actual contribution can be made up until the personal tax filing deadline (October 15, 2021 if an extension was filed).
- Pretax and/or after-tax (Roth) funds can be used to make employee deferral contributions.
Profit Sharing Contribution
- A sole proprietorship may make annual profit-sharing contributions to a Solo 401k plan on behalf of the business owner and spouse.
- IRS Code Section 401(a)(3) states that employer contributions are limited to 20% of the business entity’s taxable income. Schedule C sole-proprietors base their maximum contribution on earned income. IRS Publication 560 contains a step-by-step worksheet for this calculation.
- In general, your net earnings from self-employment activity defines the term “compensation”. This definition considers the following eligible tax deductions: (1) the deduction for half of the self-employment tax, and (2) the deduction for contributions on your behalf to the Solo 401k plan.
- A sole proprietor’s Solo 401k contributions for profit-sharing must be made by the tax-filing deadline (October 15 if an extension was filed).
Single Member LLC
Not much changes here compared to the sole proprietor.
Employee Deferral. The owner of a single member LLC may make employee deferral contributions. It can be as much as $19,500 to a Solo 401k plan for 2020. Those 50 and older can tack on a $6,500 annual catch-up contribution each year. This can bring their annual deferral contribution to as much as $26,000 for employee deferral.
Solo 401k contribution deadline rules dictate that plan participants must formally elect to make an employee deferral contribution by Dec. 31. However, you have until the tax filing deadline to make those contributions. Pretax and/or after-tax (Roth) funds make up employee deferral contributions.
Profit Sharing Contribution. A single member LLC business may make annual profit-sharing contributions to a Solo 401k plan. This must be on behalf of the business owner and spouse.
Again, the IRS states that employer contributions must be 20% of the business’s taxable income. Schedule C sole-proprietors must base their maximum contribution on earned income. See IRS Publication 560 for full instructions.
A single member LLC’s Solo 401k contributions for profit sharing must be made by its tax-filing deadline (October 15 if an extension was filed).
S Corp
For a corporation, you must do employee salary deferral contribution through the payroll. Using a W-2 form, an employee of a C Corporation or S Corporation can make a deferral contribution at any time within the year when the income to be contributed is earned. The timing of the contribution typically will depend on the corporation’s payroll structure.
If the corporation uses a payroll company, the employee’s paycheck will automatically include the deferral contribution deduction. Let’s say the company does not use a payroll company. An employee can elect to make a deferral contribution at any time during the year. The Department of Labor’s safe harbor guidelines requires the deferral contribution to a Solo 401k account is made within seven days of the date on which the employee elects to make the contribution.
Pretax and/or after-tax (Roth) funds can be used to make employee deferral contributions.
Profit Sharing Contributions. The corporation may make annual Solo 401k contributions for profit sharing. Contributions fix at 25% of the compensation paid, per Internal Revenue Code Section 401(a)(3). The corporation must make any profit-sharing contributions before its tax-filing deadline. This is on October 15, 2021, or September 15 depending on business structure. You can also include tax deadline extensions for contributions.
Partnership and Multi-member LLC
Basically, this is the same contribution process as a single member LLC unless you have a different extension date (could be either October 15, 2021, or September 15 depending on the business structure).
