Login | November 15, 2024
S corporations, solo 401 (K)s and RMDS
JULIE JASON
The Discerning Investor
Published: November 14, 2024
If you own an S corporation that offers a 401(k), what are your rules when it comes to required minimum distributions (RMDs) if you are still working past age 73?
This is a question posed by a reader, who said she and her husband own 100% of an S company. "[My husband] will be 73 next year," she said. "Does he need to start his RMD on his solo 401(k) next year?" A solo 401(k) is a "traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse," according to the IRS website (tinyurl.com/2epc4j2b).
While I can offer a general overview, anyone in the reader's situation will need to consult with his or her tax adviser before taking action to be sure to avoid potential tax penalties -- each individual's tax situation is unique.
First, some background. Internal Revenue Code Section 401(a)(9)(C) sets out the rules for starting RMDs. The required beginning date (RBD) for employees to begin taking RMDs is "April 1 of the calendar year following the later of (I) the calendar year in which the employee attains applicable age, or (II) the calendar year in which the employee retires" (tinyurl.com/5b737t2d). That age is now 73, after the passage of SECURE Act 2.0 in 2022.
Translation: Even if you are 73 or older, you can delay taking an RMD from a 401(k) administered by your current employer as long as you are still working for that company -- but not in all cases; there are exceptions to this rule.
One exception affects the reader. Quoting IRS Pub. 575, "If you are a 5% owner [of the 401(k)'s sponsor], you must begin to receive distributions from the plan by April 1 of the year that follows the calendar year in which you reach age 73."
What defines a 5% owner? According to Pub. 575, "You are a 5% owner if, for the plan year ending in the calendar year in which you reach age 73, you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer, or more than 5% of the capital or profits interest in the employer."
The 5% rule applies to the reader's S corporation. Since the husband and wife together own 100% of the S corporation, the participant is considered as owning more than 5%. As a result, he must start RMDs at age 73 whether or not he continues working, according to Mark Luscombe, principal analyst at Wolters Kluwer Tax and Accounting.
The reason? "Ownership of the S stock owned by the spouses is attributed to each other," Luscombe explained. "Therefore, in this example, each would be considered to own 100% of the S corporation" for purposes of the RMD.
This rule applies to pre-tax 401(k)s. There is another exception that needs to be understood if the 401(k) is a Roth. "Under prior laws, RMDs were required to commence even for Roth 401(k)s at age 73," Luscombe said. "However, starting in 2024, RMDs are no longer required from Roth 401(k) accounts until the death of the participant."
Let me add a note on solo 401(k)s. A business owner "wears two hats in a 401(k) plan: employee and employer," quoting the IRS page. "Contributions can be made to the plan in both capacities."
Those capacities include elective deferrals (with a limit of $23,000 in 2024, or $30,500 if age 50 or over), and employer nonelective contributions. However, the total contributions (not counting catch-up contributions for those 50 and over) can't be more than $69,000 for 2024.
Again, for anyone in this reader's situation, consult your tax adviser. You don't want to be assessed an IRS penalty for failing to take your RMDs in a timely manner (up to 25% of the amount not taken; see tinyurl.com/yc7au55k for more details).
Seasoned investment counsel (tinyurl.com/52nus8hz) and award-winning columnist and author, Julie Jason, JD, LLM, promotes financial literacy and investor protection. Read her latest book, "The Discerning Investor: Personal Portfolio Management in Retirement for Lawyers (and Their Clients)" (tinyurl.com/4u7h9pjs), published by the American Bar Association. Write to Julie at readers@juliejason.com. While all questions cannot be answered, each email is read and reviewed and can lead to discussion in a future column.
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