A solo 401(k) plan in which the only participants in the plan are the business owners and spouses of course, the spouses are employees of the business. There are no other "common law" employees employed by the business.
Those who qualify to establish a solo 401(k) plan are:
* Business owners (sole proprietors, partners and shareholders;
* Spouses of the business owner(s)
* Business owners and spouses are the only employees of the business.
The advantages of a solo 401(k) plans compared to SEP's, SIMPLE 401(k) plans or SIMPLE IRA plans are:
* Largest retirement plan contributions by the employer. ($54,000 or 100% of participants compensation).
* Two types of Contributions:
* Salary deferral-deferrals of up to $ 18,000 deducted from employee's W-2 wages;.
* Profit-sharing - 25% of employee's wages self-employment income. If participant is a sole proprietor or a partner, the contribution is based on income of the business limited to 25% of self-employment income.)
* The salary deferral and profit sharing contribution may not exceed $54,000 when combined.
* Loans from the plan up to $50,000 or 50% of the participants account balance.
The flexibility available to the employer regarding the annual amount of profit-sharing contributions.
* The employer may contribute as much as the lesser of 25% of a participant's income not to exceed $54,000. The profit-sharing contributions is limited to the maximum less the amount of employee's deferral.
* Profit-sharing annual contribution may be between 0% up to 25% of compensation. Thus, in very profitable years, employer may contribute the maximum. For low activity years, employer may choose to forgo making a contribution. Alternatively, employer may contribute more than 0% but less than 25% of participants compensation.
General rule for excluded gain on sale of primary residence: If a taxpayer owns and uses the home for any two of the five years looking back from the date of sale, taxpayer may exclude $ 250,000 of gain (not sales price). If only one taxpayer of a married couple meets the ownership and use test, the exclusion is up to $ 250,000 if both spouses meet the ownership and use test, the exclusion is up to $ 500,000.
Rental residential property converted to primary residence and later sold:
Before January 1, 2009. The above general rule applies in the determination of the excludeable gain.
Beginning for sales after December 31, 2008, the calculation of the amount of gain excludeable changed. The calculation is best explained by an example.
Taxpayers purchased a rental house on January 1, 2007. On January 1, 2014, the taxpayers converted the rental house to a primary residence. On January 1, 2016, the taxpayers sold the house for a $ 300,000 gain.
First, the period of ownership of the house must be bifucated into tow period-qualified and non-qualified use.
The qualified use includes the ownership period before January 1, 2009 coupled with the period the home was used as a principal residence. Thus, the qualified use consists of 2007,2008,2014 and 2015.
The non-qualified use includes 2009,2010,2011,2012 and 2013.
The amount of the $ 300,000 gain that is excluded is the ratio of qualified use to total period of ownership. The total ownership period is, therefore, nine years. The qualified period of ownership is four years. The percentage of the total gain is 44.44 (4/9). Thus, $ 133,320 of the $ 300,000 gain is excluded from income. The remaining $ 166,680 which represent depreciation taken while the house was rented is taxed at a maximum 25% rate. The $ 166,680 net of depreciation is long-term capital gains.
IMPORTANT EXCEPTION TO THE ABOVE.
If the house is used as a primary residence and afterwards converted to rental property, the rules are more favorable to the homeowners.The gains up to $ 250,000/$ 500,000 are excluded from income except the amount of post May 6, 1997 depreciation taken while the house was being rented. The "depreciation recapture" is taxed at a maximum rate of 25%. This exception to the above rule is well reasoned because there are occasions when the homeowners desire to sell the property. After the property has been on the market for a protected period of time, the property is rented until the housing market improves.
Warning: Remember, the home must be used as a principal residence for two out of five year looking back from the date of sale to qualify for the exclusion. Renting the property for more than three years destroys the exclusion.
Federally Authorized Tax Practitioner included those enrolled to practice before the Internal Revenue Service, attorneys, and CPA's. These are authorized to represent clients at all administrative levels of the IRS, which include audits, payment/collection issues, and appeals Unlimited Representation Rights.
Below is a brief description of each class of the three classes of those who have unlimited represention rights:
* Enrolled Agents - Licensed by the IRS. Enrolled agents are subject to a suitability check and must pass a three-part Special Enrollment Examination, which is a comprehensive exam that requires them to demonstrate proficiency in Federal Tax Planning, individual and business tax return preparation, and representation. They must complete 72 hours of continuing education every three years.
* Certified Public Accountants - Licensed by state boards of accountancy, the District of Columbia, and U.S. territories. Certified public accountants have passed the Uniform CPA Examination. They have completed a study in accounting at a college or university and also met experience and good character requirements established by their respective boards of accountancy. In addition, CPA's must comply with ethical requirements and complete specified levels of continuing education in order to maintain an active CPA license. CPA's may offer a range of services' some CPA's specialize in tax preparation and planning.
Licensed by state courts, the District of Columbia or their designees, such as the state bar. Generally have on-going continuing education and professional character standards. Attorneys may offer a range of services; some attorneys specialize in tax preparation and planning.
Limited Representation Rights:
Some preparers without one of the above credentials have limited practice rights. They may only represent clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. They cannot represent clients whose returns they did not prepare and they cannot represent clients regarding appeals or collection issues even if they did prepare the return in question. Tax return preparers with limited representation rights include.
Annual Filing Season Program Participants
This voluntary program recognizes the efforts of return preparers who are generally not attorneys, certified public accountants, or enrolled agents. It was designed to encourage education and filing season readiness. The IRS issues an Annual Filing Season Program Record of Completion to return preparers who obtain a certain number of continuing education hours in preparation for a specific tax year.
Beginning with returns filed after Dec. 31, 2015, only Annual Filing Season Program participants have limited practice rights.
PTIN Holders -
Tax return preparers who have an active preparer tax identification number, but no professional credentials and do not participate in the Annual Filing Season Program, are authorized to prepare tax returns. Beginning January 1, 2016, this is the only authority they have. They have no authority to represent clients before the IRS (except regarding returns they prepared and filed December 31, 2015, and prior).1
There are also those taxpayers who prepare their tax returns themselves. These buy off-the-self tax preparation software, file through an online portals or prepare the return by hand.
For most taxpayers their tax returns from year-to-year are pretty much the same as the one the year before. However, most taxpayers experience infrequent complicated events which are out-of-the ordinary. These extraordinary events often require a more knowledgeable and experienced tax professional than the professional ( or do-it-your-selfers) that they have engaged for many years. In other words, the expertise required to handle the tax ramifications of the event properly is above the tax professional's pay grade.
At ASHEVILLE TOTAL TAX SOLUTIONS, we specialize in assisting taxpayers and their tax professional in finding the answer to these infrequent, complex income tax issues. Although at ASHEVILLE TOTAL TAX SOLUTIONS, we engage in tax preparation work, we are not interested in expanding that tax services. Thus, the taxpayer is encouraged by us to return to their tax professional or to buy off-the-shelf tax preparation software to fill their tax compliance needs
ASHEVILLE TOTAL TAX SOLUTIONS is staffed with Enrolled Agents. It is now expanding its tax consulting/advisory division as well as assisting clients in procuring favorable private letter ruling from the National office of the IRS.
1 Internal Revenue Service website.
Many employers contemplating the establishment of a profit sharing plan mistakenly think its contribution must be allocating in a uniform manner among participants. It is a fact that the allocation may not discriminate in favor of owners and highly paid employers. The rank and file employees must be treated fairly. Thus, the Plan must meet certain non-discriminatory test in order to be a qualified plan.
Additionally, in the context of a defined contribution plan, the amount of the employer's annual contribution to the plan is discretionary. In the event of a year in which profits are less than for most years, the employer may skip making a contribution or contribute much less than it normally does.
Age-weighted and new comparability allocation methods may be tested for non-discriminatory purposes on either a benefits or a contributions basis. An example for an age-weighted allocation is given below to point out why testing on a benefits basis is not discriminatory in situations in which there are discriminatory among the ages of participants.
We will look to a subcontractor, owner of the employer, age 55 and his helper age 30. The owner has ten years left before he attains age 65. Under the age-weighted method of allocating employer's contribution, the employer must pass the General test using "cross-testing" (i.e., projected future benefits derived from the present-day allocation to the helper muster be comparable to projected future benefits derived from the present-day allocation to the owner.
If we use the same "testing age" (i.e., 65) and the same interest rate and mortality assumptions, both the owner and the helper are to receive comparable benefits at age 65. However, the lump sum accumulations to pay those benefits must also comparable. In order to accumulate comparable lump sums at age 65, using the same interest (between 7.5% and 8.5%) and the same mortality assumptions, the annual allocations for the owner must be much larger than those for the helper. Not only is the lion's share of the employer's contribution allocated to the owner, the total contribution both of them is much smaller because of the young age of the helper. Most small business owners see this as a win-win situation.
Following is an illustration of the power of interest compounding and the importance of investing early in life:
Bill invest $2,000 at the beginning of each year beginning at age 19 and continuing through age 26. Bill makes no additional investments to the account after age 26. For simplicity, we assume Bill's account earns 10% annually, compounded annually. At age 65, Bill's account balance is $1,035,160. Bill's total investment for the eight years totaled $ 16,000. Money earned on money is the wealth creator.
Phil begins investing $2,000 at the beginning of each year at age 27. Phil continues investing $2,000 annually through age 65. Phil's account balance after his investment for age 65 is $883,185. Phil's total investment is $78,000 over 39 years. Again, money earned on money is the factor that creates wealth.
Traditionally, employer contributions to a profit-sharing plan are allocated to participant's accounts in proportion to the ratio of that participant's compensation bears the total of all participants' compensation. The maximum annual contribution the employer is allowed to make to the plan is 25% of total compensation.
There is a more equitable variation for allocating the total contribution among plan participants. It is called an age-weighted profit sharing plan. As its name suggests, an age-weighted profit-sharing plan is one that takes age into account in the formula for allocating employer contributions as well as relative compensation. This results in higher contribution allocation for older workers than younger employees. Most "founders" are older than the other workers. They, therefore, receive a greater allocation of the employer contribution. Additionally, the long serving employees tend to also be older, thus, the faithful are rewarded with a larger allocation than workers who are more recently hired.
In order to allocate benefits in an age-weighted manner and still comply with the rules that govern tax-qualified retirement plans, an age-weighted profit sharing plan must be a "uniform points plan" in which each employee is allocated points based on age, service, and compensation. The employer contribution is allocated in proportion to each employee's total points. The result often is the owner is credited with as much as 90% of employer contribution.
This arrangement is not unfair. For example, the retirement benefit at age 65 for the 50 year old owner will be much less than the retirement benefit of a 25 year old participant at his/her age 65. There is, indeed, magic in compounded earnings.
Yes, a traditional profit sharing plan can be converted into an age-weighted plan.
Since attempting to adopt an age-weighted profit-sharing plan requires special planning, please do not hesitate to call us to make an appointment so that we can assist you in adopting and implementing this type of plan.