Small Business 401k Eligibility Requirements

Historically, small businesses have not adopted 401k plans because they have not presented favorable tax advantages. This changed with the Economic Growth and Tax Relief Reconciliation Act of 2001, which created a new class of 401k specifically aimed at small business owners. The small business 401k goes by any number of names depending on the offering institution, but it is generally referred to as the SBO-401k. It applies to any business where the eligible participants are limited to business owners.

Documentation Requirements

You will need to file documentation for your 401k plan by December 31 in the year prior to the year you will establish the plan. Thankfully, most financial institutions offer shorter versions of the application documentation for SBO-401ks as opposed to traditional 401ks. You may need to fill out only two or three pages to complete your application. 

Employee Eligibility Requirements

The major requirement for participation in the SBO-401k plan is that the employees be owners of the business. Any type of business is eligible, including a sole proprietorship, partnership or corporation, as long as it follows this primary rule. If you are married and employ your spouse, he or she may also be eligible for the plan. Any employee who does not hold equity in the business cannot be eligible for the plan, or you must select a different structure for your 401k. You may have employees, but they must not be eligible for your plan. 

Eligibility Restrictions

You cannot unduly restrict employees from participating in your plan. You may choose to exclude any employee under the age of 21 and remain within the plan guidelines. You may also choose to exclude any employee that has not worked with the company for at least one year from making contributions. Finally, you may prevent any employee who is in a profit-sharing arrangement from entering your plan until he or she has been employed for two years. In general, 1,000 hours of service constitutes one year with a company. As a result, you can choose to have employees work less than this minimum amount in order to continually exclude them from your plan. Generally speaking, if you set your requirements in a fashion that would qualify individuals who are not owners to be eligible for the plan, you will exclude yourself from operating an SBO-401k. This is the most nuanced part of the plan restrictions, and great attention must be paid to stay within boundaries. 

Small Business 401k Benefits

On the whole, if you are eligible to set up a 401k for your business, you will see many benefits not offered to those simply setting up an IRA. The largest benefit is the ability to provide company matching of funds in the 401k. With one paycheck, you can deposit your personal contribution and add your company's contribution, both of which may be tax deductible. This makes it easier to place funds in the account, and it can also make tax accounting easier in the future. Further, you can offer plan participation to potential shareholders in the business. 

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