Employees and Solo(K) Plans — Like Water and Oil

Yes, employees and Solo(K) plans don’t mix.  As much as it is preaching to the choir, one can never talk about this topic enough.

Okay, you are self-employed and you have had success with your business.  You believe you have the need to add an employee to assist you with the business, and you give no thought to how this may impact your 401(k) plan…or whether you need to include this “employee” in your plan.   In your mind you may rationalize not including them because you think, “he/she is not part of the business…it is still MY self-employed business.”  but the chances are that the IRS and DOL (Department of Labor), probably won’t agree with this thinking.

Say it can’t happen to you?  You know the rules.   Well, don’t be too sure.   Depending on the circumstances involved, there is probably a very good chance that person would be considered an employee and, therefore, needing to be included in the plan.   And, the plan documents for your plan may dictate the employee be included as a participant in your “Solo(K)….immediately.  Ooops, you might not have thought of that.

Exceptions to an Employee Being Immediately Eligible?

Before you do that hard swallow and say “what the?”, the employer’s (your) requirement of whether the employee must be immediately included in the plan, may hinge on several factors….including how your 401(k) plan defines employee eligibility.  You see, as the Trustee of your one-participant 401(k) plan, you have the ability to create and amend your plan documents for plan eligibility.  You can create a probationary period for an employee to meet to be eligible.

Of course, you can’t just “set” whatever probationary period of time you want.  But, your plan documents can permit a probationary period of up to one year (12 months after full-time employment) with a semi-annual enrollment.  For example, if you hired a full-time employee on January 2, 2016, you may be able to exclude that individual from being included in the plan up to the one-year probationary period (January 2, 2017) with enrollment taking place at the next semi-annual enrollment period (July 1, 2017).  You would want to make sure that your documents are written to include this probationary period.

Of course, most plan documents already define eligibility to exclude certain categories of individuals:  employees under 21 years of age and employees who do not work more than 1,000 per year.  When designing  your plan documents, you will want to inquire as to how your plan documents can define employee eligibility….as you just never know.

What is an Employee?

It may be good to define an employee so you also have an idea of other options you may have versus hiring an employee.   An employee is one who:

1)  Performs duties dictated or controlled by others (meaning you if you are the business owner)

2)  Is given training for the work they are doing or to be done

3)  Works only for you (the business owner) in the scope of performing these functions and responsibilities.

Another Option…..An Independent Contractor?

With that caveat, if you are not wanting an employee, another legitimate option potentially available to you is retaining the services of an independent contractor, or 1099 professional.  In considering this option, how is a 1099 defined:

1)  Operates their business under a different business name;

2)  May have his or her own employees;

3)  Maintains a separate checking account;

4)  Advertises his/her business’ services;

5)  Invoices for work completed;

6)  Has more than one client;

7)  Possesses their own “tools” (actual tools, intellectual property) for their craft and sets their own hours.

8)  Keeps his/her own business records.

Beware…!

Also, one wants to be careful if they retain the services of an independent contractor.  There are business owners who are “liberal” with their belief that they have retained the services of an independent contractor when, in fact, the person may be defined as an employee based on the aforementioned eight points.  You want to ensure that the individual is truly a 1099 professional.  If the IRS ever concludes that a 1099 person is, in fact, by definition a W-2 employee, you may be subject to:

  • Reimbursing “employee” for past wages;
  • Payment of back taxes and penalties for federal and state income taxes, etc.
  • Pay any misclassified injured employees workers’ compensation benefits
  • Provide employee benefits, including health insurance, retirement, etc.

…all I can say is YIKES!

Most self-employed individuals do not hire any employees.  But, in case you do, consider not only the options of how your plan defines “eligibility”, but also how you might employ the services of a 1099 professional.

As always, the information provided is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult your respective professional in all such matters.