The Biggest Misconception About Solo 401k Eligibility
The Solo 401k rules state that only self employed business owners without any full time employee can qualify to set up the plan. Many real estate investors set up an LLC for their rental business, thinking that this LLC will qualify them for the Solo 401k plan. However, this is a misconception that can lead to unwanted tax consequences. The Solo 401k plan can even be disqualified if it doesn't meet the eligibility requirements.
The Solo 401k eligibility
To qualify for a Solo 401k plan, the plan owner must show proof of a self-employed business activity. This can be in the form of jobs as an independent contractor or consultant. It can also be in the form of a business, whether a sole proprietorship, a partnership, LLC, or corporation.
Usually, as long as the business does not employ any other full time employee, aside from the owner and his or her spouse, then it will qualify for a Solo 401k plan.
You cannot set up a Solo 401k with an LLC that only collects rental income
Many investors and Solo 401k plan providers misinterpret the qualification requirements above. Many real estate investors set up an LLC for their rental business. They assume that this LLC is eligible to sponsor a Solo 401k.
However, if an LLC is only set up to collect rents, it may not be considered an eligible sponsor for a Solo 401k plan.
Rent payments are considered passive income. If the LLC only collects and distributes rental income to the owner, this income will not be considered wages and cannot be contributed to a retirement account.
Who is qualified for a Solo 401k
Only businesses that can provide wages and earned income to the owner can qualify for a Solo 401k plan. Such businesses provide the plan owner, also the employer and employee of the business, with income that can be reported on Schedule C.
You can have a business of any form - sole proprietorship, LLC, or corporation - as long as you receive compensation from the business.
The self directed Solo 401k can offer great benefits to plan owners such as high contribution limits, the ability to invest in real estate, and checkbook control. You will also have access to a Roth account, which can offer tax-free earnings. The participant loan option is also available.
These benefits however are only made available to qualified individuals. To avoid tax consequences and disqualification of the Solo 401k plan, you need to do your due diligence and make sure your business meets the requirements.
For more information on self-employment please visit this page on IRS website:
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