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Deduction Confusion with Solo 401(k)


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As a self-employed individual, navigating the world of taxes can be overwhelming and confusing. One aspect that can cause confusion is reporting deductions for solo 401(k) contributions. With both an employee and employer component, it can be difficult to determine where and how to report these contributions. In this blog post, we will discuss the different options for reporting solo 401(k) deductions and offer some guidance for self-employed individuals like yourself. However, it is important to note that we are not tax advisors and it is always best to consult with a tax professional for specific advice regarding your individual situation.

The Basics of Solo 401(k) Contributions

Before diving into the confusion surrounding deductions, it's important to have a basic understanding of solo 401(k) contributions. As a sole proprietor with no employees or family members on the plan, you are considered both the employee and the employer. This means that you are responsible for both the employee and employer contributions.

The employee contribution is the amount you contribute to the 401(k) from your own earnings. The 2023 maximum contribution limit for the employee portion is $22.5K. On the other hand, the employer contribution is the amount you contribute to the 401(k) on behalf of yourself as the employer. The 2023 maximum contribution limit for the employer portion is 25% of your adjusted income.

Conflicting Information

Now, let's address the confusion surrounding where to report these deductions. Half of the information out there, including IRS Publication 560, suggests reporting the employee portion on Schedule C, line 19 and the employer portion on Schedule 1, line 16. However, the other half suggests reporting both portions on Schedule 1, line 16.

So, which is correct? Unfortunately, there is no clear answer. The IRS has not provided specific guidance on this issue, leaving self-employed individuals like yourself unsure of how to proceed. It is always best to consult with a tax advisor for personalized advice, but we can offer some general guidance to help you make an informed decision.

The Numbers

To better understand the situation, let's look at an example. Say your net profit for the year, reported on Schedule C, line 31, is $40K. Your self-employment taxes, reported on Schedule SE, line 12, would be $6,120 ($40K x 0.5 = $3,060). Your employee contribution for the year, based on the 2023 maximum, would be $22.5K. The employer contribution, based on the 2023 maximum and your net profit after deducting self-employment taxes, would be $0.25 x ($40K - $3,060) = $9,235.

Based on this example, you may be wondering if you should report the total contribution of $31,735 ($22.5K + $9,235) on Schedule 1, line 16. However, it is unclear if this is the correct approach. Some suggest reporting only the employer portion, while others suggest reporting both the employee and employer portions. Additionally, there is no consensus on whether or not to also report some portion of the contribution on Schedule C.

Using the Deduction Worksheet for Self-Employed

Another source of confusion is the "Deduction Worksheet for Self-Employed" found in IRS Publication 560. This worksheet is meant to help self-employed individuals calculate their allowable deductions for a solo 401(k). However, it is not clear how this worksheet determines the employer contribution or if it should be used at all.

Seeking Professional Guidance

As mentioned earlier, the best course of action is to consult with a tax professional for personalized advice on how to report deductions for your solo 401(k). They will be able to review your individual situation and guide you on the best approach for reporting these deductions.

In conclusion, the confusion surrounding deductions for solo 401(k) contributions is understandable, and unfortunately, there is no clear answer. It is always best to seek guidance from a tax professional to ensure you are reporting these deductions correctly. We hope this blog post has provided some clarity on the issue, but please remember to consult with a tax advisor for personalized advice. Thank you for reading and best of luck with your solo 401(k) contributions!