IRS Audits Focus on Solo 401(k)s

In the past, in terms of 401(k) participation rules, most part-time employees didn't qualify for employee status — only traditional full-time employees who worked at least 1,000 hours in any 12-month period had to be offered participation rights. 

Post-SECURE Act, however, certain long-term, part-time employees must be granted eligibility to participate in the employer-sponsored 401(k). Under the new law, employees who perform at least 500 hours of service for at least three consecutive years (and who are at least 21 years old) must also be allowed to participate in the employer-sponsored 401(k). Employers aren't required to count years before 2021 in determining whether an employee must be granted participation rights.

The IRS is also interested in whether small entrepreneurs have exceeded the annual pretax contribution limits. As noted above, taxpayers can contribute to a solo 401(k) as both employer and employee. However, the deferral limits apply on a per-person basis, not a per-401(k) basis. Many entrepreneurs who operate "side gigs" form their own solo 401(k)s to take advantage of the increased pretax contribution limits while also participating in an employer's plan.

Documentation is another issue that commonly gets put on the back burner. The solo 401(k) sponsor is required to maintain a written plan document and operate the plan in accordance with that document. It's important to update the document from time to time to reflect changes in the tax law. With the significant changes we've seen in the past few years, every solo 401(k) sponsor should be reminded of the need to review the plan document carefully to make any required changes.

Conclusion

Performing relatively routine self-compliance checks is key to avoiding unwanted attention from the IRS. And with solo 401(k)s on the radar for 2021, small-business clients should begin those examinations now so that they can correct any errors before the IRS takes notice.

___________________

• Learn more with Tax Facts, the go-to resource that answers critical tax questions with the latest tax developments. Online subscribers get access to exclusive e-newsletters.
• Discover more resources on finance and taxes on the NU Resource Center.
• Follow Tax Facts on LinkedIn and join the conversation on financial planning and targeted tax topics.
• Get 10% off any Tax Facts product just for being a ThinkAdvisor reader! Complete the free trial form or call 859-692-2205 to learn more or get started today.