Solo 401(k)

How it works

A solo 401(k) is what the IRS calls a one-participant 401(k): a fully qualified 401(k) plan limited to the owner of a business, or the owner and a spouse, with no other common-law employees. The plan document looks like any other 401(k). What makes it worth a page of its own is that the owner sits on both sides of it at once.

On the employee side, the owner can make an elective deferral under Section 402(g), a flat dollar amount taken from compensation or net self-employment earnings. It is deductible if taken pre-tax, or, if the plan allows a Roth deferral, not deducted now in exchange for a tax-free qualified withdrawal later. Either way, the deferral does not depend on how profitable the year was. A thin year and a strong year support the same elective deferral, within the annual limit.

On the employer side, the business can make a profit-sharing contribution of up to 25 percent of compensation under Section 404(a)(3), deducted by the business itself. For a self-employed owner the effective rate works out closer to 20 percent of net earnings, because the contribution reduces the very compensation figure it is measured against. Reasonable salary sets the base for an S corporation owner instead, since only W-2 wages count as compensation for this purpose, not distributions.

Both contributions land in the same bucket, and that bucket has one overall ceiling: the annual-additions limit under Section 415(c)(1)(A), adjusted for inflation every year. A catch-up contribution for an owner age 50 or older sits outside that ceiling entirely, under Section 414(v). A larger version of that catch-up applies to owners age 60 through 63, and it replaces the standard catch-up for those ages rather than stacking on top of it. One condition rides on top of both: Section 414(v)(7) requires the catch-up to be made as Roth where the participant's prior-year FICA wages from the sponsoring employer exceeded an indexed threshold, $150,000 of 2025 wages for a 2026 catch-up. That test runs on FICA wages, so it reaches an owner drawing a W-2 from an S corporation and does not reach a sole proprietor whose income is net earnings from self-employment rather than wages. Total compensation counted for any of this is itself capped under Section 401(a)(17), a limit that moves with inflation as well.

This is one plan with two contribution sources feeding a single cap, not two separate plans sharing a name.

A SEP-IRA offers only the employer side of this. With no deferral to add, a SEP has to reach the same total contribution entirely out of the employer percentage, which takes a larger base of compensation to get there. A solo 401(k) reaches the same place on less income, because the deferral is a flat amount that does not scale with earnings the way the employer share does.

What this is worth in Florida

Florida has no individual income tax, so the deduction only does anything at the federal level here. The Roth choice inside a solo 401(k) is where that shows up most directly. Choosing Roth means giving up a current deduction in exchange for a tax-free withdrawal later. In a state with a real income tax, that traded-away deduction was worth something today. In Florida it was not, since there was no state deduction to give up in the first place, which tips the decision slightly toward Roth for a Florida owner relative to someone filing the same facts in a high-tax state.

Who this applies to

Any owner-only trade or business can sponsor one. A sole proprietor or single-member LLC filing on Schedule C works, and so does a partnership, an S corporation or a C corporation. The plan is sponsored by the business, not by the individual.

The gate is not the entity type. It is headcount. The plan stays a one-participant plan only while it covers the owner, or the owner and a spouse, and no other common-law employee who meets the plan's age and service eligibility rules under Section 410(a). A spouse who earns compensation from the same business can be covered too, making an elective deferral and receiving an employer contribution in their own right, which roughly doubles what the household can put away while the plan is still, on paper, a one-participant plan.

The compensation the contribution is based on is not the same for every owner. A self-employed owner's compensation is net earnings from self-employment under Section 401(c)(2): net Schedule C or K-1 income, reduced by the deductible half of self-employment tax and by the plan's own contribution. An S corporation owner's compensation is W-2 Box 1 wages only. Distributions are not compensation for this purpose at all, which is why the wage an S corporation owner sets also decides how much the plan can hold.

This does not work for a business with any other eligible common-law employee. Independent contractors are not common-law employees, so a genuine 1099 relationship does not disturb the plan. A misclassified one does, which is worth naming here even though the consequences show up later.

What it requires

A written plan document has to exist, and the deadline for adopting it runs later than most people expect. Section 401(b)(2), as amended by SECURE 2.0, lets the employer adopt the plan any time up to its tax return due date, including extensions, and still deduct an employer contribution for the year just finished. A sole proprietor with no other employees gets one further carve-out: in the plan's first year only, the elective deferral election itself can be made as late as the return due date without regard to extensions. Outside that first-year carve-out, a deferral election has to be made by year-end like any other 401(k).

The plan needs its own trust account at a custodian, separate from the owner's personal accounts, and its own EIN if the plan will ever need to file a return.

• Two contribution sources, computed correctly. The elective deferral is a flat dollar figure. The employer share is up to 25 percent of compensation under Section 404(a)(3), or the roughly 20 percent effective rate for a self-employed owner once the circular calculation is worked through under Section 401(c)(2).
• One combined ceiling. Section 415(c)(1)(A) caps the deferral and the employer contribution together, with the age-based catch-up under Section 414(v) added on top rather than inside that number.
• Funding by the deadline. An employer contribution is deductible if it is made by the business return's due date, including extensions, under Section 404(a)(6).
• A filing obligation that depends on size. Once the plan's total assets exceed $250,000 at the end of a plan year, aggregated across every one-participant plan the owner maintains, Form 5500-EZ has to be filed for that year. At or under that figure, nothing has to be filed at all. A final return is required in the plan's last year regardless of size.

What you need to document

The signed plan document, dated

The adoption date is what the Section 401(b)(2) deadline is measured against, so keep the executed document with that date on it.

The compensation worksheet

A self-employed owner's contribution runs through the Section 401(c)(2) rate calculation, not a flat 25 percent of net income. Keep the worksheet that shows the math, not just the final number.

Deposit records for both contribution sources

Bank or custodial records showing when the elective deferral and the employer contribution actually moved, matched against the deadline each one is measured by.

Evidence the plan is still one-participant

Payroll records or contractor agreements showing that nobody besides the owner and a covered spouse met the plan's eligibility rules for the year. A hidden eligible employee is the most frequent reason one of these plans fails, and this is the record that rules one out for the year.

Form 5500-EZ filings, or the asset figure that says none was due

Once the plan is required to file, keep the filed returns. Before that point, keep whatever year-end statement establishes that total assets stayed under the filing threshold.

Where it goes wrong

None of this is an aggressive position. It is a mainstream, IRS-sanctioned plan design, not a listed transaction, and nothing about it turns on a characterization argument. What goes wrong is operational: a deadline missed, a number computed on the wrong base, or a fact about the business that changed without the plan changing with it.

The disqualifying event that happens quietly

Hiring, or already having, a non-spouse common-law employee who meets the plan's eligibility rules is the single most common way this plan stops being what it claims to be. Nothing announces the moment it happens. The plan simply becomes a regular 401(k) subject to coverage testing under Section 410(b) and nondiscrimination testing, and continuing to run it as a one-participant plan afterward is the failure, not the hire itself. Part-time staff are worth watching closely here, since the long-term part-time eligibility rules can bring someone into the plan sooner than expected.

Treating a true common-law employee as a 1099 contractor to keep the plan looking owner-only is the classic version of this same failure, and it does not stay hidden forever. A reclassification on examination adds the eligible employee retroactively, and the plan's whole basis for existing as a one-participant plan goes with it.

Funding it off the wrong number

An owner who also participates in a 401(k) through a W-2 job runs into this one often, because the Section 402(g) deferral limit applies to the person, across every plan they are in, not once per plan. Deferring the full amount at the day job and again through the solo 401(k) creates an excess deferral that has to be corrected by a timely distribution, or it is taxed twice. On the employer side, the failure is applying 25 percent to self-employed compensation directly instead of running the Section 401(c)(2) calculation, which overstates the contribution by more than it looks like it should. For an S corporation owner, the failure runs the other way: setting a low salary to save on payroll tax also shrinks the wage base the employer contribution is built on, a trade-off worth seeing before it is made rather than after.

The paperwork failure

A missed Form 5500-EZ after plan assets cross the filing threshold carries a penalty of $250 for every day the return is late, capped at $150,000 for the plan year. A late filer who has never filed at all can generally still seek the IRS's penalty relief program under Revenue Procedure 2015-32, which is worth checking before assuming the exposure is whatever the raw penalty math suggests. The other recurring paperwork failure is conflating the two SECURE 2.0 deadlines: an employer contribution is timely if the plan is adopted by the extended return due date, but the first-year sole-proprietor deferral election has to be made by the due date without the extension. Treating those as the same date is a common and avoidable mistake.

A situation where this comes up

The version I see most often is an owner already funding a SEP-IRA who wants to put more away on the same income and finds out the SEP was never going to get there, because it only has the employer side to work with. I lay out the full comparison in solo 401(k) vs. SEP-IRA. Adding the deferral hat through a solo 401(k) does not require the business to change anything about how it operates. It requires a plan document adopted on time and a custodian willing to hold a one-participant plan, and very little else changes on the ground.

The case that worries me is the S corporation owner who set a low salary on purpose, for the payroll-tax reduction, without connecting that decision to what it does to the employer contribution. The employer share is built on W-2 wages, so a salary set low for one reason quietly caps what the plan can hold for an entirely different reason. Nobody did anything wrong. The two decisions were simply never looked at together, and by the time the contribution comes up short, the salary has already been paid and reported.

The other pattern worth naming is the owner who takes on help, even part-time, and never circles back to ask whether the plan is still what it was when it was adopted. The plan does not send a notice when it stops being a one-participant plan. It quietly stops being compliant as one, and the gap tends to surface later, usually at the worst time to find it.