Advice - Did I screw up choosing a Solo 401(k) for my S-Corp?

[ufekevom]

I work as an independent contractor and am paid through an LLC I set up for myself and which for the 2022 year, I elected to be taxed as an S-Corp (also I have no other employees). 2022 was my first year as a non-W2 worker, so I'm a bit new to this. But I think I screwed up choosing a solo 401(k) and my accountant, soon to be former accountant, has not been a lot of help.

Allowable Contribution Calculations

I wanted to see how successful my solo venture turned out before committing to a retirement contributions, but throughout the year I paid myself a nominal W2 salary through the company. Luckily the venture turned out to do well and the company made enough that 25% of its net adjusted earnings would have been able to provide max the $61k for the SEP (entirely from the company) or the solo 401(k) (20,500 from my salary, and 40,500 from the company). However, it seems I misunderstood the usage of earnings in my situation and the 25% is actually not calculated from the Company's earnings, but as the amount I paid myself in salary which was quite low. (Is this actually correct?)

Timing of Contributions

So prior to the end of 2022 I set up a solo 401(k) which I'm planning to fund prior to my tax filing. If the above is true, I assumed this was better than the SEP because I could still contribute $20,500 as an employee and 25% of my salary as an employer (which would add about another ~$14k) whereas the SEP would only allow me to contribute the 14k. However I now read in several places that the employee contribution must be made within 7 days of each paycheck and that I can't just fund the $20,500 all at once, meaning I'd be left with only being able to contribute the $14k from the Employer portion. Is this true? How would the IRS even know and why would they allow you to setup a solo 401(k) until the end of the calendar assuming that your W2 wages would be paid throughout the year?

TLDR questions -

1) Is it correct that for a sole owner/employee LLC taxed as an S-Corp that the max 25% employer contribution for a solo 401(k) is calculated off of the W2 wages paid to the owner as an employee and not 25% of the revenue of the company (or the amount that would be part of the distribution in the K-1)

2) If #1 is correct, does the Employee portion of the contribution need to be made "in a timely manner" (within a week I believe) of being paid or can I just write a check to fund the entire employee contribution prior to the tax filing date. I only set up the account in December which is allowed so it didn't exist when I ran payroll the first 11 times in 2022. And is there a proper way that you need to separate employer/employee contributions when making the payment to the fund?

 

[resjudicata]

@ufekevom 1) yes. The whole point of an S Corp is to separate yourself as employee and yourself as employer (in contrast to sole proprietor, where the two are the same). That allows you to make it so business profit is not compensation; both the good (avoiding FICA) and the bad (it is not eligible compensation for retirement plans).

2) Employer contributions can be made until the tax filing deadline (March 15 for S corps) plus extensions (September 15 if you file for an extension prior to March 15).

The employee contributions are a bit tricky: they were required to have been reported on form W2, the deadline for which was January 31. If you failed to report them on your W2 you are out of luck. If you did report them already, then the same deadlines as above apply for actually making the contribution.

 

[sustainableblueberry]

@resjudicata Employee contributions must also be withheld from salary payments, and those salary payments must be in the calendar year, since the payroll date determines the year of contribution. Just like with a normal business.

 

[sustainableblueberry]

@ufekevom Employer contributions for SEP and for Solo 401k are calculated the same way. They are 25% of salary.

1. Yes, Employer contributions are a business expense to the business reported on your 1120-S and will reduce the passthrough income on the K-1.
2. Employee contributions must have a written election dated before contributions begin and kept on file. They must be deducted from salary with a payroll date in the year that you wish to make the contribution for. A 2022 contributions would need to be deducted from salary paid in 2022.

How you designate employee vs. employer contributions at your custodian is dependent on the custodian.

The IRS allows you to set up a Solo 401k at any time because employer contributions can be made up to a deadline into the next year. You have until March 15 to make 2022 employer contributions.