Solo 401(k) and Minor Children as Employees. What Now? | USTaxAid

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Solo 401(k) and Minor Children as Employees. What Now?

Written by Diane Kennedy, CPA on September 26, 2022

I received this question recently at USTaxAid. If you have a tax question, here’s how to Get Your Tax Question Answered.

If you have a business, chances are you’ve thought about a pension at some point. There are several options such as SEP-IRA, 401(k) all the way to the more complicated defined benefit plan.

A popular pension if you have a closely held business is to set up a Solo 401(k). If you are comparing the Solo 401(k) with a SEP-IRA, you’ll likely find that you are able to put more in the Solo 401(k) pension plan. Plus, there is a Roth Solo 401(k) option that can be added.

 

The traditional 401(k) is offered primarily by brokerage firms. It does not always allow for participant loans and there is no “checkbook control” meaning you don’t have easy access to the investment funds and their management

 

On the other hand, a Solo 401(k) allows the participant to self-direct the investments and to invest in alternative non stock investments such as real estate, trust deeds, tax liens and private shares. It is much easier for the participant to borrow from their plan and it can be invested in life insurance for the business owners.

There is one potential challenge with a Solo (401K), though. That is, only employees and possibly their spouses can be participants. That’s it, you can’t have any other employees  in the business if you want a Solo 401(k).

 

It’s no wonder why many of my clients who qualify prefer the Solo 401(k).

That all leads up to this question that I received at USTaxAid:

 

What happens to a Solo 401(k) plan if the couple’s minor children are employed in the business?

Well, on the surface, it seems like you have a problem. In order to have a Solo 401(k), the only employees can be the owner and possibly a spouse. If there is more than one unrelated owner, you need a traditional 401(k) not a Solo 401(k).

 

In the case of minor children, there could be a loophole though. If the children work less than 1,000 hours per year, they do not need to be included in the pension plan. That means you can keep the Solo 401(k) and employ your children in the business. but they could not participate in the Solo (401K).Your children could have their own traditional IRA or Roth IRA instead.

 

We discuss current real life tax strategies for business owners and real estate investors as part of Wednesday Coaching.

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