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Reporting Requirements

Mega backdoor Roth within the Solo 401k

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What it is

The mega backdoor Roth strategy is a way to get more Roth funds into your retirement account. Roth funds are taxed initially but grow tax-free.

The mega backdoor Roth strategy consists of:

  • Making after-tax contributions to the Solo 401k, and
  • Converting those after-tax contributions to Roth within the Solo 401k, and
  • Keeping those Roth funds in the Solo 401k for checkbook-control investing or rolling over the funds into a Roth IRA

The Mega Backdoor Roth strategy offers an alternative to contributing to a Roth IRA directly, which is limited to $6,500 per year by the IRS. Many individuals also do not qualify for a Roth IRA due to their high earnings.   

Your Solo 401k with Sense Financial already includes the features which allow you to utilize the mega backdoor Roth strategy.

How it works

  • Open separate accounts for your Solo 401k to house your after-tax contributions and Roth funds, if you do not have these already

From a banking standpoint, these separate accounts will be identical. Both are in the name of your 401k and using the EIN of your 401k. However, these accounts are established to keep the funds separate from each other and to assist you in your accounting of each type of fund within your 401k. You can assign nicknames to the separate accounts online in order to differentiate them.

  • Calculate the after-tax contribution based on your self-employment business earnings
  • Make the after-tax contribution into the 401k account for after-tax contributions
  • Once that after-tax contribution is in your 401k, immediately convert the funds to Roth and move those funds to the Roth account

Note that the growth on the after-tax contribution is taxable, so you will want to convert the after-tax contribution to Roth immediately after the contribution is made.

  • Keep those funds within the Roth account of your Solo 401k for checkbook-control investing or roll those funds over to a Roth IRA
  • The following year, file a 1099-R to document the conversion

How it should be reflected on a 1099-R

In this case, the 1099-R should document the conversion of the after-tax contribution to Roth within your 401k. The Payer is your 401k trust, which is issuing the 1099-R to you, the Recipient.

  • Payer: your 401k trust
  • Payer TIN: the EIN of your 401k trust (not the EIN of your adopting business)
  • Recipient TIN: your SSN
  • Recipient: you, as an individual
  • Box 1: Gross distribution: amount that was converted to Roth
  • Box 2a: Taxable amount: 0.00 if the after-tax funds were converted to Roth immediately. The taxable amount would be 0.00 since the after-tax contribution was not originally claimed as a deduction and was converted to Roth immediately. If the after-tax contribution was not converted to Roth immediately, the growth amount is taxable and should be entered here.
  • Box 5: Employee contributions/Designated Roth contributions or insurance premiums: amount of the original after-tax contribution. If you converted the after-tax contribution to Roth immediately after making the contribution, this should be the same amount as in Box 1
  • Box 7: Distribution code: G which indicates a direct rollover (from after-tax to Roth) within the plan, your 401k

When the 1099-R should be filed

The 1099-R is filed in the year following the year in which the Roth conversion was performed (e.g. the 1099-R for 2022 is filed in 2023). There are two deadlines for the 1099-R:

  • The Payee/recipient copy must be received by January 31st
  • The electronic copy must be filed with the IRS by March 31st

You are responsible for the filing of the 1099-R by both deadlines.

Sense Financial can assist with the filing of the 1099-R by request only, provided that we receive your request by our deadline of the second Monday in January.

Reporting CARES Act distributions and repayments

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The IRS has released Form 8915-E and 8915-F for the reporting of CARES Act distribution(s) that were taken in 2020, their repayment, or their inclusion in income.

If you took a CARES Act distribution in 2020, note which form(s) would apply to you:

Form 8915-E is used to report:

  • If you took a CARES Act distribution in 2020

Form 8915-F is used to report:

  • Your income in 2021 if you took a CARES Act distribution in 2020 and have been including in your income in equal amounts over 3 years and that 3-year period has not yet lapsed
  • Your repayments of a CARES Act distribution, if repaying the distribution

Note that repayment of the CARES Act distribution can be done over 3 years, starting with the day after the distribution was received. Repayment(s) can occur through multiple payments or one lump sum payment by the end of those 3 years. If the entire CARES Act distribution is paid back within that time, the distribution will not be taxed.

You will want to request your CPA’s assistance in completing the appropriate form for your situation. 

More information on these two forms can also be found at:

https://www.irs.gov/forms-pubs/about-form-8915-e

https://www.irs.gov/forms-pubs/about-form-8915-f-qualified-disaster-retirement-plan-distributions-and-repayments

Penalty relief program for Form 5500-EZ late filers

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Retirement plan sponsors who missed filing required annual reports may be eligible for penalty relief under Revenue Procedure 2015-32.

Plans eligible:

  • One-participant plans covering a 100% owner or a partnership, and their spouses (no other participants). Non-ERISA plans only.

That means your Solo 401k qualifies!

More details here:

https://www.irs.gov/retirement-plans/penalty-relief-program-for-form-5500-ez-late-filers

Form 5500-EZ filing deadline quickly approaching

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Form 5500-EZ for Solo 401k plans must be filed with the IRS by the last day of the 7th calendar month after the end of the plan year. For most of our clients, that date is July 31st (unless your plan year is different than the calendar year). Failure to file will result in severe penalties of $250 per day (not to exceed $150,000)!

We have updated our instructions which are located on the following page:

Annual Filing Requirements

As of January 1, 2021 you can use the EFAST2 filing system to file IRS form 5500 series online. This includes an online filing of IRS form 5500-EZ. The IRS has released several helpful tutorial videos:

Calculating plan assets

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I'm getting ready to file Form 5500-EZ and need help calculating the plan assets of my 401k. I used some of the funds for a down payment to purchase an investment property. The rest of the purchase price was financed using a hard money loan. My wife doesn't have any investments at this time, just some cash. How do I calculate the net plan assets?

Answer:

First, you must calculate the total plan assets. To do so, simply add up all assets plus cash for all participants. Please note that if the total plan assets exceed $250,000, you are required to file Form 5500-EZ.*

For properties owned by the 401k, the value of each property will need to be based on other properties in the area-  real estate comps, CMA, broker's price opinion or a third-party appraisal can be obtained.

Example:

Your plan owns a property valued at $220,000. There is $15,675 of cash in your checking account for the 401k. Your spouse  has $18,000 cash in her 401k account. There is a mortgage note against the property for the amount of $120,000.

Total plan assets will be calculated as:

+ $220,000.00 Value of the property
+ $15,675.78 Cash in your account
+ $18,000.13 Cash in spouse's account

Total plan assets: $253,675.91  (Note: since the total exceeds $250,000, you are required to file the 5500-EZ)*

- $119,841.09 Mortgage against the property (Total plan liabilities)
________________________________________________

Net plan assets:  $133,834.82

* Please see our detailed instructions on how to complete Form 5500-EZ below. On the form, you are required to enter a single number for total plan assets, then total plan liabilities, then net plan assets.

Annual Filing Requirement

 

How do I value real estate in my Solo 401k plan?

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My Solo 401k plan owns real estate property. How do I value that?

Answer:

The value of each property will need to be based on other properties in the area (real estate comps), or a third-party appraisal can be obtained.

Please note: if you are taking an in-kind distribution or in-kind conversion of the property (i.e. there is a taxable event), then you must use a licensed third party appraisal to determine the accurate value of the property.  The appraisal must be dated as close as possible to the taxable event.

2021 Form 5500-EZ released

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The IRS has released form 5500-EZ for 2021. We have updated our instructions which are located on the following page:

Annual Filing Requirements

As of January 1, 2021 you can use the EFAST2 filing system to file IRS form 5500 series online. This includes an online filing of IRS form 5500-EZ. The IRS released several helpful tutorial videos:

What is Form 5500-EZ?

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What is Form 5500-EZ? Am I required to file it?

Answer:

Form 5500-EZ is the filing requirement for Solo 401K plans with $250,000 or more in total plan assets.  It is a simple informational return that is filed with the IRS.  As the plan administrator, you are responsible for filing Form 5500-EZ once your plan reaches $250,000 in total plan assets.

Plans with assets totaling less than $250,000 are not required to file Form 5500-EZ.

For instructions on filing Form 5500-EZ, please visit:

Annual Filing Requirements

4 considerations for filing Form 5500

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The IRS Form 5500-EZ filing due date is July 31 for most plans (without extension). Accordingly, at this time of year, we see increased activity relative to Form 5500-EZ preparation and filing. Close and careful review of the Form 5500-EZ is advised to ensure it is properly prepared and does not unnecessarily raise red flags to the Department of Labor (DOL) and/or the Internal Revenue Service (IRS). The following is a short list of considerations and questions aimed at helping avoid government inquiry otherwise prompted by a “wrong” answer on the Form 5500-EZ. The bottom line is that it is critical to follow the Form 5500-EZ instructions and carefully review the entries in order to avoid triggering an investigation. Here are a few issues for your consideration:

  1. Use the correct plan name and plan sponsor name (as well as the correct employer identification number “EIN”). This might seem a strange recommendation, but reportedly there are a lot of missteps in this regard. Often, it is just an error; other times, changes occur as the result of the change in sponsoring entity that are not recognized and/or are not appropriately addressed.
  2. Obtain appropriate proof of the Form 5500-EZ filing (and the filing of the Form 5558 extension form). These steps are often overlooked by plan sponsors. It is easy to obtain such proofs in order to avoid an argument with the government over the imposition of potentially significant fines for not filing or for filing late. This is especially important since the penalty was recently increased to $250 per day (not to exceed $150,000)!
  3. If you failed to file a Form 5500 or will file late, quick participation in the DOL’s Delinquent Filer Voluntary Compliance Program (“DFVCP”) should be explored.
  4. The DOL and IRS continuously state that where an answer on the Form 5500-EZ is described as “other,” it will have a tendency to garner their attention. Accordingly, effort should be made to avoid using that response. As an example, we have seen recently loan interest being reported as “other,” when in fact the instructions specifically provide a place to report accrued, but unpaid interest on participant loans.

In summary, a close review of the Form 5500-EZ will likely save time and money later. It is the plan sponsor who signs and submits the form under penalty of perjury; accordingly, the signer has a keen interest in ensuring the Form 5500-EZ is properly and accurately completed. It is better to discover and address those matters sooner rather than later.

Solo 401k and personal taxes

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Can you provide guidance on what I'm required to do on the tax/CPA side of things? What should I submit to my accountant?

Answer:

IMPORTANT: Please note that we are not qualified to provide tax, legal or investment advice.  This information is intended as general guidance only.  You should always consult with an experienced tax professional regarding your personal tax situation.

For the Solo 401k plan itself, you may or may not need to submit the 5500-EZ form.  Please review the annual filing requirements HERE.

As plan administrator of your Solo 401k, it is your responsibility to maintain the recordkeeping of the plan.  This includes the contributions, distributions, investments, etc.  All recordkeeping forms are located under the Maintenance tab within “Miscellaneous Forms.”

For your personal taxes, you will need to report contributions made to the plan:

  • Employee elective deferral contributions are reported on the first page of your personal tax return (Form 1040). Remember:  if your plan is sponsored by a corporation, you need to process contributions through the payroll.  All contributions will need to be reflected on the paycheck as well as on Form W2. See HERE for details.
  • Employer profit sharing contributions are reported on the corporate tax return.  If your plan is sponsored by a sole proprietorship or single-member LLC, this contribution needs to be reported on your Schedule C.

Other things that would affect your personal taxes are:

  • Roth conversion
  • Distribution
  • Defaulted loan*

* The Solo 401k loan is in default when the cure period has passed.  The loan is then considered as a distribution and is taxable and reportable as income.

All of the above are taxable events. If you perform any of the above, you will need to report it through Form 1099-R.  As the administrator of your Solo 401k, you are responsible for filing Form 1099R on behalf of your plan. If you would like assistance with generating a 1099-R, please contact us at the beginning of January of the following year to request this service.

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