Solo 401(k) Guide | Atlanta CPA

Employee Deferrals, Employer Contributions, and Business Structure Matters

🔑 Key Takeaway (Read This First)

If you are self-employed or own a small business with no full-time employees, a Solo 401(k) can be the most powerful retirement and tax-reduction strategy available. However, the ability to maximize tax-deferred retirement contributions depends heavily on how your business is taxed.

Sole proprietors generally have more flexibility in funding employee deferrals after year-end, while S-Corporation owners are limited by W-2 wages and payroll timing rules. Understanding these distinctions can mean tens of thousands of dollars in additional tax-deferred savings each year.

What Is a Solo 401(k)?

A Solo 401(k) (also called an Individual 401(k) or Self-Employed 401(k)) is a retirement plan designed for business owners who:

• Have no employees other than themselves, or
• Employ only a spouse

It combines the benefits of an employer-sponsored 401(k) with the flexibility of self-employment retirement planning.

The defining feature of a Solo 401(k) is that the owner contributes in two roles:

1. Employee salary deferral, and
2. Employer profit-sharing contribution

This dual structure is what allows Solo 401(k) plans to outperform SEP IRAs and SIMPLE IRAs in many situations.

Part 1: Employee Salary Deferrals (Core to Tax-Deferred Growth)

For 2025, employee deferral limits are:

• $23,500, or
• $31,000 if age 50 or older (includes catch-up)

These limits apply whether you are a sole proprietor, single-member LLC, or S-Corp owner.

Why employee deferrals matter

Employee deferrals:

• Reduce current-year taxable income
• Grow tax-deferred (or tax-free if Roth)
• Are not subject to self-employment tax or payroll tax

How Employee Deferrals Work for a Sole Proprietor

If you operate as a sole proprietor or single-member LLC (not taxed as an S-Corp), employee deferrals are based on earned self-employment income, not payroll.

Compensation definition

For Solo 401(k) purposes, compensation equals:

Net Schedule C income
minus one-half of self-employment tax

As long as this earned income is sufficient, the full employee deferral is allowed.

Election deadline (critical compliance step)

A written salary-deferral election must be completed by December 31 of the tax year.

This election:

• Does not require funding by year-end
• Simply documents intent to defer income

Funding deadline (major advantage)

For sole proprietors, the actual employee deferral may be funded:

• Up to the tax filing deadline, including extensions

For 2025 contributions:

• April 15, 2026, or
• October 15, 2026 (if extended)

This timing flexibility is a major reason why the Solo 401(k) for sole proprietors is such a powerful tax planning tool.

How Employee Deferrals Work for an S-Corporation Owner

For a single-member LLC taxed as an S-Corp, the rules change significantly.

Compensation limitation

Only W-2 wages qualify for:

• Employee salary deferrals
• Employer contributions

Distributions and business profits do not count.

Election deadline

Just like sole proprietors:

• A written deferral election must be made by December 31

Funding rules (key restriction)

Employee deferrals must be:

• Withheld from payroll, and
• Deposited shortly after payroll is run

S-Corp owners cannot wait until tax filing season to fund employee deferrals.
If payroll is not run in the tax year, the deferral opportunity is lost.

Part 2: Employer Profit-Sharing Contributions

In addition to employee deferrals, Solo 401(k) plans allow employer contributions.

Employer contribution limits

Sole Proprietor

• Up to 20% of net self-employment earnings
• Based on: Net profit − ½ SE tax

S-Corporation

• Up to 25% of W-2 wages

These contributions are deductible business expenses and significantly enhance tax-advantaged retirement savings.

Total Solo 401(k) Contribution Limits for 2025

Employee deferrals

• Employer contributions

May not exceed:

• $70,000, or
• $77,500 with catch-up

Reaching the maximum depends entirely on:

• Net profit (sole proprietor), or
• W-2 wages (S-Corp)

Why Business Structure Impacts Retirement Planning

Sole Proprietor Advantages

• Contributions tied to net income
• No payroll requirements
• Employee deferrals can be funded after year-end
• Often allows higher retirement contributions

S-Corporation Trade-Offs

• Contributions limited by reasonable salary
• Payroll timing restrictions
• Lower salaries reduce 401(k) contribution limits
• Must balance payroll tax savings vs. retirement funding

This is why entity selection and retirement planning must be coordinated, not done in isolation.

Which Retirement Plan Allows the Highest Tax-Deferred Contributions?

1. Defined Benefit / Cash Balance Plan (highest potential deductions)
2. Solo 401(k) (best defined contribution plan)
3. SEP IRA
4. SIMPLE IRA

In many cases, a Solo 401(k) combined with a Cash Balance Plan delivers the greatest tax savings for high-income business owners.

Final Thoughts

A Solo 401(k) is one of the most effective tools available for self-employed retirement planning, but only when implemented correctly. Understanding employee deferral elections, funding deadlines, and entity-specific contribution limits is essential to avoiding missed opportunities and IRS compliance issues.

If you’re evaluating an S-Corp election, starting a new LLC, or looking to maximize retirement contributions for 2025, proactive planning can produce substantial long-term benefits.

At EAS Income Tax Services, we provide comprehensive Atlanta tax services—including tax resolution, tax preparation, and accounting. Whether you’re a local small business or an individual dealing with IRS problems nationwide, we’re here to help.

If you know of anyone in need of assistance with an IRS problem, please have them call us at (404) 719-0330, or send us an email at GLG@eas.tax.