Is Individual 401(k) Profit Sharing a Pre-Tax Deduction?

401(k) profit-sharing plans allow employers and employees to contribute pre-tax money. When you are self-employed, you wear both hats, which means both you and your business can make tax-deductible contributions to an individual 401(k). You can also make after-tax contributions to an individual Roth 401(k) account.

Individual 401(k) Plan

An individual 401(k) plan lets you contribute up to $51,000 a year, as of 2013. The contributions can be in two parts. You can contribute 100 percent of your earned income up to $17,500, or $23,000 if you’re age 50 or over. Your business can contribute an additional amount. To calculate this amount, you must deduct half of your self-employment tax and all of your own contributions. The Internal Revenue Service provides rate tables and worksheets in Publication 560 to step you through the calculation.

Designated Roth Account

You can set up a designated Roth account for your individual 401(k) plan and contribute after-tax earned income to the account as long as your total contributions to the traditional and Roth portions don’t exceed the annual limits. Your business can contribute as well, but the money is tax-deductible and must go into the traditional account. You can’t intermingle the two accounts, although you can perform a taxable in-plan rollover from the traditional account to the Roth account. Once you designate a Roth contribution, you can’t change it to a pre-tax one.

Distributions

You must include distributions from the traditional account in your taxable income. If you remove money before age 59 1/2, the IRS will hit you with a 10 percent penalty tax. However, the IRS provides a number of exceptions to the penalty tax, including disability, a divorce settlement and medical costs. Designated Roth accounts tax and penalize earnings you withdraw before age 59 1/2 and earnings you withdraw before the fifth anniversary of the account's first contribution. Penalty exceptions only apply to underage withdrawals of Roth earnings, not to the five-year initial period. Money you have contributed to a Roth account has been taxed, so you can withdraw it at any time without penalty.

Reporting

Use Form 5500 EZ to file annual information about your self-employed 401(k). The due date is normally July 31 of the following year. The form reports your plan assets, contributions and rollovers. You also include the business contributions and any outstanding loans. However, if your plan has assets of less than $250,000, you don’t have to file. If you terminate your plan, you must file Form 5500 EZ and may choose to file Form 5310, which is a request for the IRS to determine whether your plan is qualified. You can roll the distributions from a qualified plan tax-free into another qualified plan or traditional IRA.