OVERVIEW
- A business owner operating any type of business entity can open a solo 401k. Owners of a sole proprietorship, LLC, partnership, C corporation, or S corporation are all eligible to open an account as long as they have no employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods (excluding a spouse).
- Depending on your business structure, there are few minor differences in how contributions are calculated, and how much you can contribute.
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There seems to be some confusion around what business entities are eligible to open a solo 401k account. Because it’s called a “solo” 401k, and also often referred to as an individual 401k or a one-participant 401k, many people assume that the plan is only for sole proprietors.
False. Whether you operate as a sole proprietorship, partnership, single-member LLC, multi-member LLC, S corporation, or C corporation, any business entity is eligible to open a solo 401k. The “solo” or “individual” in the name refers to business activity, not business structure.
The “solo” refers to the requirement that you must not have any employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods. The type of business you have doesn’t matter.
A solo 401k only has two requirements:
- You must have self-employment activity.
- You must not have any employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods (other than your spouse).
As long as you have no employees, you’re allowed to open a solo 401k. The only exception to this rule is your spouse. Your spouse is the only person allowed to work full-time in your business without any restrictions. And when they earn income from your business, they can also open a solo 401k and your household can essentially double your contributions each year.
However, while any business entity can have a solo 401k, there are some key differences, particularly around contribution limits on the employer side.
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Sole Proprietorship
A sole proprietorship is the simplest business structure to have. If you open a business, and you’re the only owner, you’re automatically a sole proprietorship by default (even if you don’t register your business with the state). But just because you have a sole proprietorship, it doesn’t mean you automatically qualify for a solo 401k by default (which is what many people falsely assume). Despite its name, a sole proprietorship CAN hire employees.
A sole proprietorship can only open a solo 401k if it doesn’t have any employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods (excluding their spouse).
Contribution Limits for a sole proprietorship
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Approximately 20% of your income as an employer.
- A sole proprietorship doesn’t provide a W-2 salary to the business owner. Adjusted earned income is used instead. This is the net income from your tax Schedule C or C-EZ. Adjusted earned income is also referred to as net adjusted business profit. It’s calculated by taking gross self-employment income and subtracting business expenses. Then, take that and subtract half of the self-employment tax.
Partnership
Another assumption with the solo 401k is that any business with partners or multiple owners are disqualified. False again. You can open a solo 401k even if you operate as a partnership. The rule that your business must have no employees ONLY applies to employees. Partners are allowed. In fact, this works the same way even if you have a different business structure (like an LLC, s-corp or c-corp) that has multiple partners.
To apply for a solo 401k as partnership, your plan provider will create a customized solo 401k plan that simply excludes them from the plan. The exclusion will not be by name. For example, if your business partner’s name is Jim, the plan cannot state that “Jim is excluded from the plan,” since that’s discrimination. Instead, Jim’s role in the business is excluded from the plan.
Contribution limits for a partnership:
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Approximately 20% of your income as an employer.
- A general partnership doesn’t provide a W-2 salary to the business owner. Adjusted earned income is used, instead. This is the net income from your tax Schedule C or C-EZ.
LLC
You can open a solo 401k as an LLC, as long as you have no employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods (excluding your spouse). This is true whether you operate as a single-member LLC or as a multi-member LLC. For multi-member LLC’s, your plan provider will simply exclude their roles from your solo 401k plan.
Contribution limits for an LLC
With an LLC, your contributions depend on whether you get taxed as a sole proprietorship or as a corporation.
For an LLC taxed as a sole proprietorship
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Approximately 20% of your income as an employer.
- An LLC taxed as a sole proprietorship doesn’t provide a W-2 salary to the business owner. Adjusted earned income is used, instead. This is the net income from your tax Schedule C or C-EZ.
For an LLC, taxed as a corporation
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Up to 25% of your income as an employer.
- An LLC taxed as a corporation would use the compensation listed in your W-2 box 1 with Box 12 pre-tax contributions added back in.
S Corporation
Business owners operating an S corporation can open a solo 401k if they have no employees. However, only earned income is eligible. Distributions you receive as a shareholder do not count.
Contribution limits for an S corporation
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Up to 25% of your income as an employer.
- An S corporation would use the compensation listed in your W-2 box 1 with Box 12 pre-tax contributions added back in.
C Corporation
Business owners operating a C corporation can also open a solo 401k as long as they don’t have any employees in their business. The same with an S corporation, only earned W-2 income is eligible. Distributions you receive as a shareholder do not count as eligible income.
Contribution limits for a C corporation
- Up to 100% of your income, up to a maximum of $22,500 ($30,000 if age 50+) for 2023.
- Up to 25% of your income as an employer.
- A C corporation would use the compensation listed in your W-2 box 1 with Box 12 pre-tax contributions added back in.
Summary
The assumption that only sole proprietors can apply for a solo 401k is false. Even sole proprietorships become ineligible for a solo 401k once they hire employees.
A business owner with any business structure can open a solo 401k, as long as they have no employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods (excluding their spouse). There are no age, income, or business structure restrictions. And, all business entities receive the full tax advantages and perks of a solo 401k account. It’s not like one type of business structure receives better perks than another.
However, there are some minor differences in how the contribution limits are calculated for each one.
- For sole proprietorships, partnerships, and LLCs taxed as a sole proprietorship, employers are able to contribute up to 20% of their Adjusted earned income.
- For C corporations, S corporations, and LLCs taxed as corporations, employers are able to contribute up to 25% of their W-2 earnings.
FREE PDF DOWNLOAD
The Solo 401k Handbook
Everything you need to know in a handy ebook format.
Set up a new solo 401k in under 10 minutes
Contribute up to $69,000 and invest in any asset class with tax-free compounding†.
Anyone who makes money from a business, freelancing, or a side hustle is eligible, as long as you have no employees.
