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I expect that in 2022, my income will exceed the deduction limits for a traditional IRA, so any contributions I make to it will be non-deductible. My understanding is that once I make a non-deductible contribution to my traditional IRA, I could, in the future, be subject to the pro rata rule.

However, 401(k) plans, including traditional Individual 401(k) plans, don't seem to be subject to the pro-rata rule. Can I follow this process to avoid the pro rata rule in the future?

  • Apply for a federal EIN as a sole proprietor.
  • Use that EIN to set up an Individual 401(k) plan at a place like Vanguard
  • Roll over all of the funds in my current traditional IRA (which, as of now, are all pre-tax) into the traditional Individual 401(k)

This seems like a "too good to be true" loophole in the pro rata rule. It sounds very clever but my default assumption is that it's either wrong or that the IRS is considerably more clever than me googling things. Even though my sole proprietorship wouldn't have any income (because I'm a W2 employee for my actual employer), rollover contributions aren't subject to the $57K annual contribution limit.

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  • Do you actually own/operate a business? Or would you be applying for the EIN as a sole proprietor under entirely fictional pretenses?
    – yoozer8
    Mar 30, 2021 at 16:56
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    Even if possible, it's a lot of paperwork and effort to get around - what? The pro rata rule doesn't cost you any money or taxes, it's just annoying form filling. Your idea sounds like jumping from the kettle in the fire?
    – Aganju
    Mar 30, 2021 at 16:59
  • @Aganju Why doesn't the pro rata rule cost any money? It affects what is taxed at ordinary income rates.
    – Michael A
    Mar 30, 2021 at 17:02
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    Pro rata means that conversions/withdrawals from your IRA are done proportionally from post-tax and pre-tax money; and only the pre-tax money gets taxed. But in the long term, all your pre-tax money gets taxed either way, and all your post-tax money not. At max, it moves the taxing timing around, but you control that.
    – Aganju
    Mar 30, 2021 at 17:07
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    If neither you nor your spouse had a 401k contribution during the year, you do not have an income limit for deducting Traditional IRA contributions.
    – user102008
    Mar 30, 2021 at 19:01

1 Answer 1

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You can set up a Solo 401(k) Plan if you wish and roll over all your Traditional IRA money (all of which is pre-tax) into it if the plan allows it, but any 401(k) contributions into your Solo 401(k) Plan must come from self-employment income, not from your W2 income or investment income. If you contribute any cash into the Solo 401(k), the IRS will assume that it came from self-employment income, and look to collect SS and Medicare taxes on the self-employment income. If the plan says that you are limited to 15% salary or $19,500 whichever is smaller and you contribute $6K (same as IRA limit), that $6K can be presumed to be 15% of your self-employment income and bingo, you owe income tax on $40K of presumed self-employment income plus employer's share of SS tax (assuming your W2 wages have passed the employee limit for SS withholding) plus employer and employee share of Medicare tax etc.

I am not sure all this is worth the avoidance of the pro rata rule, but obviously, ymmv.

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  • Note that "must come from self-employment income" just means "the amounts contributed must be below the limits derived from self-employment income". Money is fungible.
    – BrenBarn
    Apr 6, 2021 at 5:38
  • @BrenBarn Yes, of course, money is fungible. But as far as I can tell, the OP doesn't have self-employment income or self-employment activities at all; or any plans to do is in the future. He simply wants to get an EIN for self-employment income, use it to set up a Solo 401(k) plan, and roll over all his IRAs into the Solo 401(k) plan. I was simply pointing out that if the OP ever contributed any money into the Solo 401(k) plan, it would be assumed to be from wages that the OP paid himself, and thus he would owe self-employment taxes on the imputed wages.
    – Dilip Sarwate
    Apr 6, 2021 at 15:57

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