Monthly Archives: January 2025

Three Problems with Roth Solo 401(k) Employer Contributions

Late 2022 ushered in a new type of contribution to Solo 401(k)s: Roth employer contributions. Traditional employee and employer contributions have been available for all of the Solo 401(k)’s post-EGTRRA history. Roth employee contributions have been available since 2006, even if plan providers were slow to adopt them. 

Should the availability of Roth employer contributions change planning for most solopreneurs? Not to my mind. 

I have three concerns with making Roth employer contributions to Solo 401(k)s.

First Concern: Validity

Roth employer contributions were part of SECURE 2.0, which was part of the Omnibus bill passed in December 2022. That Omnibus bill has been subject to litigation. In Texas v. Garland (accessible here and here), Judge James W. Hendrix ruled for the State of Texas that the House of Representatives impermissibly used proxies to establish a quorum in order to pass the Omnibus, in violation of the Constitution’s Quorum Clause. 

I encourage you to read the Texas v. Garland opinion. It is very convincing in my opinion. 

While Texas v. Garland does not technically apply to SECURE 2.0, its reasoning does. Any taxpayer in the country facing harm under SECURE 2.0 (perhaps because they were denied the deduction for catch-up contributions under SECURE 2.0 Section 603) can pick it up and ask another federal judge to invalidate SECURE 2.0. That leaves SECURE 2.0 on shaky footing.

Short of litigation, there’s the question of what the new Administration will do with the Omnibus and SECURE 2.0. Texas v. Garland is litigation between the old Department of Justice and Ken Paxton, the Attorney General of Texas. Ken Paxton is much closer aligned politically with the Trump Administration. Will the Trump DoJ continue to litigate against Ken Paxton? The Trump Administration may simply refuse to uphold the Omnibus, including SECURE 2.0. 

My hope is that if that happens taxpayers who have relied on SECURE 2.0 will be held harmless. For example, amounts in Roth 401(k)s (including Solo 401(k)s) attributable to employer contributions should be deemed to be amounts validly within the Roth 401(k) plan, so past reliance does not cause future harms (such as failed plan qualification). That said, my hope, a reasonable hope, is just a hope.

Regardless of one’s views on the Quorum Clause litigation, there’s at least some doubt as to SECURE 2.0’s validity, including the validity of Roth employer contributions to Solo 401(k)s. That makes planning into them difficult, in my opinion. 

Second Concern: Section 199A Problem

Ben Henry-Moreland of Kitces.com wrote a thoughtful article on Roth employer contributions to Solo 401(k)s potentially reducing a solopreneur’s Section 199A qualified business income deduction.

I both agree and disagree with Mr. Henry-Moreland. I agree in a general sense that recent IRS guidance has muddied the waters when it comes to tax return reporting of Roth employer contributions to Solo 401(k)s. I disagree with his conclusion that this guidance results in non-deductible Roth employer contributions to Solo 401(k)s reducing the Section 199A qualified business income deduction.

The concern is Roth employer contributions might reduce the amount of qualified business income that then determines the Section 199A QBI deduction. Mr. Henry-Moreland is concerned about this because of Notice 2024-2 Q&A L9 (page 76 of this file). It tells plans how to report Roth 401(k) employer contributions in general. The question is “what reporting obligations apply to [Roth employer] contributions?”

Before I state the concerning answer, one must remember the context. This particular Q&A is about reporting, not about taxation. In theory, Roth employer contributions (taxable to the employee) should be simply added to W-2 income for most employees. But that creates a huge headache from a large employer systems perspective. That’s W-2 income that is income tax taxable but not payroll tax taxable. Ugh!

To avoid the payroll systems issue (which is mostly a large employer issue rather than a Solo 401(k) issue), the Notice provides that Roth employer contributions are reported “as if: (1) the contribution had been the only contribution made to an individual’s account under the plan, and (2) the contribution, upon allocation to that account, had been directly rolled over to a designated Roth account in the plan as an in-plan Roth rollover.” (emphases added). The Notice goes on to state that because of this treatment the Roth employer contribution is reported to the employee as taxable on a Form 1099-R. 

Mr. Henry-Moreland is concerned that as applied to a Schedule C solopreneur, this is reported by deducting the contribution from net self-employment income (presumably on Schedule 1, Line 16) and then taxing the amount on Form 1040 Lines 5a and 5b. This reduction of net self-employment income would result in a reduction in the Section 199A QBI deduction.

While I hear Mr. Henry-Moreland’s concern, I disagree with it for several reasons. First, the Q&A in question applies to reporting by plans. It does not appear to apply to (1) determining taxable income or other tax relevant amounts and (2) tax return reporting by individuals. It is telling that the answer is silent as to any forms filed by individuals while it goes into depth as to how the Form 1099-R is to be filed.

Second, the words “as if” in the Notice’s answer are illuminating. The reporting is done “as if” X and Y happened for tax purposes. That means X and Y did not happen for tax purposes, which is good news from a Section 199A perspective. Third, the Notice does not purport to affect Section 199A in any way. Fourth, qualified business income is determined under Section 199A and Treas. Reg. Section 1.199A-3. Neither SECURE 2.0 Section 604 nor Notice 2024-2 mention Section 199A and qualified business income. Thus, I believe that Notice 2024-2 and Roth employer contributions to Solo 401(k)s do not reduce the qualified business income deduction. 

The above views voiced, there may be some small risk that Roth employer contributions to Solo 401(k)s are not only nondeductible, they also reduce the qualified business income deduction. That’s a negative when assessing their desirability from a planning perspective. 

How to Report Solo 401(k) Roth Employer Contributions on 2024 Tax Returns 

What follows is my academic opinion, not advice for you or anyone else. To properly report Roth employer contributions to a Solo 401(k) made in 2024 for 2024 and arrive at the correct Section 199A QBI deduction, I believe the following is the best way to proceed: 

(1) Report Schedule C income and deductions as normal. This should help generate the appropriate Section 199A QBI deduction. 

(2) Report the amount of the Roth employer contribution to the Solo 401(k) in full in Box 5a of Form 1040. 

(3) Assuming no other pension, annuity, 401(k), or other qualified plan distributions, report $0 for the taxable amount of pension and annuity distributions in Box 5b of Form 1040. 

My view is that the above will properly report that which must be reported to the IRS while also (i) avoiding any double counting and (ii) properly computing the Section 199A QBI deduction that the taxpayer is entitled to. 

If anyone at the IRS or the Treasury Office of Tax Policy is reading this, it would very helpful for the government issuing guidance (1) clarifying that no, Roth employer contributions to Solo 401(k)s do not reduce the Section 199A qualified business income deduction and (2) illustrating the proper tax return reporting for Roth employer contributions to Solo 401(k)s. 

Third Concern: Planning Desirability

For this section, let’s assume that I am wrong when it comes to the first concern and I am correct regarding the second concern. Making those two assumptions, Roth employer contributions to Solo 401(k)s are valid and do not reduce the Section 199A QBI deduction. 

Great!

Does that mean we should plan into such contributions? I believe the answer is generally “No” for most solopreneurs.

Even with the “deduction-reduction problem” issue with traditional Solo 401(k) contributions, traditional Solo 401(k) contributions are often going to be better than Roth Solo 401(k) contributions. 

Picture a solopreneur in the 24% marginal tax bracket. He or she can make employer contributions to a traditional Solo 401(k) and save 19.2 cents on the dollar (24% times 80% to account for the reduction to the Section 199A QBI deduction). 

Okay, well, how is that money taxed in retirement? I’ve done blog posts and YouTube videos about this subject. Some of that money could be taxed at 0% because of the standard deduction (the Hidden Roth IRA), then against the 10% bracket and then against the 12% bracket. We can hardly say traditional contributions are always the “right answer,” but we can acknowledge that (1) retirees tend to be lightly taxed in retirement and (2) retirees greatly benefit from today’s tax environment, including large standard deductions and progressive tax brackets. 

I question the planning value of Roth employer contributions. Say you disagree with me. You still have Roth employee contributions. Why not hedge your bets by making Roth employee contributions and deductible traditional employer contributions? Both of these types of contributions are well established under the law.

Conclusion

Roth employer contributions to Solo 401(k)s are on shaky legal ground and are not that desirable from a planning perspective. There’s even a chance they reduce the Section 199A QBI deduction. Based on those concerns, I believe Roth employer contributions to Solo 401(k)s are undesirable for most solopreneurs. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Los Angeles Tax Delay

The 2025 fires in Los Angeles have been devastating. My heart goes out to all those affected, and you are in my prayers.  

Los Angeles County now has a deadline delay for their 2024 tax returns, 2024 and 2025 tax payments, and IRA contributions. 

Los Angeles County Tax Deadline Delay

The IRS announced that because of the January 2025 fires in Los Angeles, Angelenos have an extended deadline, October 15, 2025, to perform most 2024 tax acts that otherwise would have been due early in 2025. The Franchise Tax Board has followed suit and also issued their own delay announcement with respect to California state income tax returns and payments. 

2024 Traditional and Roth IRA Contributions

The deadline for Los Angeles County residents to make 2024 contributions to traditional and/or Roth IRAs has been extended to October 15, 2025. As a practical matter, I wouldn’t encourage reliance on this particular deadline delay. Financial institutions may find it difficult to allow “late but timely” 2024 IRA contributions on their platform when it is available only to residents of a single county. 

If you are an Angeleno reading this after April 15, 2025 and want to make an IRA contribution for 2024, I recommend initiating the process by calling the financial institution rather than using the financial institution’s website.  

2024 Backdoor Roth IRAs

Los Angeles County residents now have until October 15, 2025 to execute the first step of a 2024 Backdoor Roth IRA, the nondeductible contribution to a traditional IRA for 2024. This would be a Split-Year Backdoor Roth IRA. 

2024 HSA Contributions

The deadline for making 2024 HSA contributions is October 15, 2025.  

2024 Tax Returns and Payments and 2025 Q1 Through Q3 Estimated Tax Payments

Los Angeles County residents now have until October 15, 2025 to (i) file their 2024 federal and California income tax returns, (ii) pay the amount due with their 2024 federal and California income tax returns, (iii) make fourth quarter 2024 estimated tax payments, and (iv) make 2025 first through third quarter estimated tax payments. 

Who Benefits?

Residents of Los Angeles County qualify for the extended deadline. Note (1) there’s no need to have suffered any loss or damage due to the fires and (2) the extensions apply to the entirety of Los Angeles County. It is not just limited to residents of the City of Los Angeles. 

Taxpayers with records in Los Angeles County can also benefit. 

Resources

IRS Los Angeles County Announcement and Additional IRS Announcement

Franchise Tax Board Los Angeles County Announcement

Treasury Regulation Section 301.7508A-1

Revenue Procedure 2018-58

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Backdoor Roth IRA Timing

Happy New Year! It’s Backdoor Roth IRA season, so let’s talk about the issue that refuses to go away . . . the timing of the two steps of the Backdoor Roth IRA. 

Recall that the Backdoor Roth IRA is a two-step transaction. First, there is a nondeductible contribution to a traditional IRA. The second step is a relatively close-in-time conversion of the nondeductible traditional IRA contribution and any minor growth to a Roth IRA. Assuming the correct profile, this can move money into a Roth IRA for a year the person exceeds the Roth IRA contribution MAGI limits. 

If there are two steps of the Backdoor Roth IRA, that begs a question: Just how long do I have to wait between the two steps, i.e., how long does the nondeductible traditional IRA contribution have to sit in the traditional IRA prior to the Roth conversion step? A minute? A day? A month? A year?

In some, but not all, cases there may have to be a few days or even a few weeks between the two steps of the Backdoor Roth IRA. Dr. Jim Dahle discussed this on a recent episode of The White Coat Investor podcast. 

The Backdoor Roth IRA and the Step Transaction Doctrine

There has been a concern with the Backdoor Roth IRA: the step transaction doctrine, which can collapse steps into a single step. In theory, the two steps of the Backdoor Roth IRA can be viewed as a single step (a direct contribution to a Roth IRA), which creates an excess contribution (subject to a potential 6 percent penalty). Michael Kitces has written that he is concerned that, because the Roth conversion step might occur so soon after the nondeductible traditional IRA contribution, the step transaction doctrine can apply to the Backdoor Roth IRA. Kitces generally advocates waiting a year between the steps based on his step transaction doctrine concern. To my knowledge he has never changed his view on the issue. 

I believe Mr. Kitces is a bit of a lone voice on the issue these days. In fact, Kitces’ own colleague Jeffrey Levine disagrees with him on the issue. 

Two late 2010’s developments moved the needle in the practitioner community towards Mr. Levine’s view. First, the IRS, in informal comments, indicated they were not too concerned with the Backdoor Roth IRA. Second, the legislative history to 2017’s Tax Cuts and Jobs Act indicated that Congressional staffers believed the Backdoor Roth IRA was valid. I believe this second development was overblown, as legislative history, to the extent relevant, is relevant to the legislation then being passed. It is not relevant, to my mind, to prior legislation (the Backdoor Roth IRA enabling legislation passed in 2006 – see Section 512). That said, both developments were informative, though certainly not binding. 

Sean’s Take

I have never been too concerned with the Step Transaction Doctrine and the Backdoor Roth IRA. In 2019, I co-wrote a Tax Notes article (available behind a paywall) about the issue with Ben Willis, my former PwC colleague. We concluded that it is not appropriate to apply the step transaction doctrine to a taxpayer’s use of the explicit, taxpayer favorable IRA rules. I believe we made a good case that the step transaction should not apply to the Backdoor Roth IRA based on the contours of the doctrine.

The Backdoor Roth IRA and Section 408(d)(2)(B)

Since 2019, I have further developed my thinking. I now believe a little commented-on rule in the IRA statute is very instructive: Section 408(d)(2)(B).

Section 408(d)(2)(B) provides that all IRA distributions during the year are treated as a single distribution. As a result, the timing of IRA distributions is irrelevant. A January 1st distribution is treated the same as a March 29th distribution, which is treated the same as a December 31st distribution. Roth conversions are distributions from an IRA. 

By grouping all IRA distributions into a single distribution, the Internal Revenue Code tells us the timing of IRA distributions, including Roth conversions, during the year is irrelevant. 

It would be exceedingly odd to apply a judicial doctrine (the step transaction doctrine) to give that timing relevance when the Code strips away that relevance. Anyone arguing the step transaction doctrine applies to a Backdoor Roth IRA is saying that the step transaction doctrine should override the specific rule of Section 408(d)(2)(B) in determining the degree of relevance afforded to the timing of the Roth conversion step. 

I strongly believe it is not appropriate to apply the step transaction doctrine when the Internal Revenue Code itself gives us a rule telling us the timing of the Roth conversion is irrelevant. 

Backdoor Roth IRA Favored Timing

I have two beliefs. First, timing is irrelevant when doing the Backdoor Roth IRA. Second, my views are not guaranteed to yield a 9-0 Supreme Court decision 😉

Based on those two beliefs, I have a third. The most desirable Backdoor Roth IRA path is to wait until the end of a month passes and then do the Roth conversion step of the Backdoor Roth IRA. This is the old Ed Slott tactic and locks in an end-of-month statement showing some interest or dividends in the traditional IRA. 

It could look something like this:

Roger contributes $7,000 to his traditional nondeductible IRA on January 2, 2025 for 2025 and invests it in a money market fund. On February 1, 2025, he converts the entire amount, now $7,027, to a Roth IRA. He has no other IRA transactions during the year and on December 31, 2025 he has $0 balances in any and all traditional IRAs, SEP IRAs, and SIMPLE IRAs.

Oh no, Roger created $27 of taxable income on his Backdoor Roth IRA. We’ve finally found something worse than IRMAA!

All kidding aside, here’s what Roger’s 2025 Form 8606 could look like (pardon the use of the 2023 form, the latest version available as of this writing): 8606 Page 1 8606 Page 2 And, yes, Roger should convert the entire traditional IRA balance, not just the $7,000 originally contributed to the traditional IRA.

To my mind, this works as a good Backdoor Roth IRA. So now you say, But Sean, what about your first belief? I thought timing was irrelevant!

I respond, (A) see my second belief and (B) what’s the downside of my desired approach? 

$27 of taxable income creates $10 of federal income tax if Roger is in the highest federal tax bracket, and Roger will have $27 more protected from future tax by the Roth IRA. 

The Backdoor Roth IRA Should Not Exist

That the Backdoor Roth IRA exists is ridiculous. It is obnoxious that our tax laws are so complicated that one of the most prominent financial planners, Michael Kitces, could plausibly claim the step transaction doctrine adversely impacts the Backdoor Roth IRA.

Let’s end all of this and adopt a rule that notorious tax haven, Canada, has adopted: Eliminate the income limit on the ability to make an annual Roth IRA contribution! Canada’s Tax-Free Savings Account (their version of a Roth IRA) has absolutely no income limit on the ability to make a contribution. America should adopt that rule as a small part of what hopefully will be a dramatic simplification of American income tax laws in 2025.

Conclusion

I do not believe that the step transaction doctrine should apply to the Backdoor Roth IRA. I do not believe that the timing of the two steps is relevant for determining their ultimate federal income taxation. That said, I like waiting until the following month to do the Roth conversion step. 

Of course, the entirety of this article is simply academic commentary. It is not tax, legal, or investment advice for you or anyone else.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.