The Wonderful Solo-K

By Jerry Kalish

Much of BizBox's content is devoted to delineating the special rewards of going into business for yourself, and no doubt they are many. But it sure does make paying taxes on a retirement plan more difficult.

If you’re self-employed, your “compensation” as it is defined for retirement plan purposes is not quite as simple as it would be if you were an employee of your company. If you were an employee, your source of personal income would be W-2 compensation, which is considered “compensation" for plan purposes. As a self-employed entrepreneur, however, the basis for making a retirement plan contribution is your “self-employment income,” or net profits from Schedule C or Schedule F. If you are a self-employed entrepreneur and contribute to a retirement plan, you must make a special computation to figure out your maximum deduction for these contributions. (These same computations must be made if you are a Partner in a partnership or a Member of a Limited Liability Company (LLC) that is taxed as a partnership.)

There is another option: the "Solo-K". This is the marketing name given (author unknown) to a retirement plan that takes advantage of tax law changes made in 2001. Before then, the maximum tax deduction that a business owner could make to a defined contribution plan had to include both profit-sharing and 401(k). EGTRRA changed the tax law so that the maximum deduction could include both profit sharing AND 401(k). The Solo-K takes advantage of this.

Under some circumstances, this tax law change may make a one-person profit-sharing plan with a 401(k) feature--a Solo-K--a viable alternative to other retirement plans for small businesses.

Let me see if I can translate all of this for you with an example.

Let's say you're a 50-year old self-employed taxpayer making $100,000 in net earnings before the retirement plan deduction in 2008. After going through the computation, self-employment income for retirement plan purposes is $92,935.23. So now what’s the maximum contribution that can be made to each of the possible retirement plans?

Maximum SIMPLE IRA Contribution: $13,206.85
Maximum SIMPLE IRA Catchup: $2,500.00
Total Maximum SIMPLE IRA: $15,706.85

Maximum SEP Contribution: $18,587.05

Maximum Profit-Sharing Contribution: $18,587.05
Maximum 401(k) Contribution: $15,500.00
Maximum 401(k) Catchup: $5,500.00
Maximum “Solo-K” Contribution: $39,087.05

And therein is the reason why so-called Solo-K retirement plans should be considered if a self-employed entrepreneur wants to contribute the maximum amount to a retirement plan. The Solo-K plan, as you can see above, is comprised of two parts, the profit sharing contribution and the 401(k) contribution. The maximum contribution is simply the sum of the two parts.

One word of caution. This is another one of the “kids don’t try this at home” tax matters. Always check with your tax advisor becoming establishing a retirement plan and making a contribution to it.

Jerry Kalish is founder and President of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm that serves private-held companies, publicly traded companies, and public sector employers. He blogs at The Retirement Plan Blog and can be reached at jerry@nationalbenefit.com.

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January 6, 2009 1:01 PM