Generally 401(k) deferrals & contributions are allowed, but there are exceptions. The biggest issue to consider is whether or not the member/owner is providing material services that are income producing for the LLC. Here is the basic checklist or list of things to consider:
- Under Internal Revenue Code Section 401(c)(1), the IRS states that “employee” includes “self-employed individual,” and that a self-employed individual is someone with earned income.
- Internal Revenue Code Section 401(c)(2) defines earned income as net earnings from self-employment (i.e., subject to tax as self-employment income) from a business where the member’s services are a material income-producing factor.
- Therefore, a member who is involved in the business has earned income.
- A member who is not involved in the business does not have earned income, regardless of the payment of self-employment tax.
- In general, a member of an LLC who provides services that are a material income-producing factor shall be considered an employee
- As an employee, the member is eligible to participate in the plan.
- The contribution shall be deducted from the member’s draw
- The member should NEVER write a personal check
- Members of LLCs that are taxed as partnerships are treated for tax purposes as though they were partners in a partnership.
If you have questions about how to best design your retirement plan including a 401(k), please give us a call at (855) 401-GAIN (4246) and press option 1, complete a form or email us at firstname.lastname@example.org.
Nothing in this post should be interpreted to be legal advice for the reader. Given that laws in this area change frequently, the read is encouraged to seek review by your legal counsel to apply the law to the particular facts of your situation.