Avoid a Hefty IRS Penalty: A Guide to Your Solo 401(k) and Form 5500-EZ
Your Retirement Plan Exposes You to a $150,000 Penalty
Do you have a solo 401(k) or a similar retirement plan? If so, you might be unknowingly exposed to a significant IRS penalty. The law mandates that you file at least one IRS Form 5500-EZ, and failure to submit this seemingly simple two-page form can trigger penalties of up to $150,000. The good news is that avoiding this hefty penalty is relatively straightforward once you understand the requirements.
What Is Form 5500-EZ?
IRS Form 5500-EZ is an information return designed to provide the IRS and the Department of Labor with essential data about your retirement plan’s operation and compliance. You are generally required to file this form if you have a one-participant retirement plan. This includes qualified plans covering only a business owner (and spouse), whether the business is incorporated or not, or covering partners (and their spouses) of a business partnership.
Examples of plans that typically require a Form 5500-EZ filing include:
- Solo 401(k) plans (also known as individual 401(k), one-participant 401(k), or self-employed 401(k) plans)
- Money purchase pension plans
- Profit-sharing plans
- Defined benefit pension plans
- Cash balance plans (a type of defined benefit plan)
- Target benefit plans
However, some retirement arrangements are exempt from Form 5500-EZ filing requirements, such as:
- SIMPLE IRAs
- Most SEP IRAs
- Traditional and Roth IRAs
- 403(b) plans for single participants
As the business owner, you are the plan administrator or plan sponsor and bear the ultimate responsibility for filing Form 5500-EZ. While you can utilize a third-party administrator to manage your plan, complete the form, and even submit it to the IRS, the legal responsibility for a correct and timely filing remains with you. It’s important to note that your income tax preparer typically won’t handle Form 5500-EZ unless specifically requested, as it’s a separate filing and not submitted with your income tax return.
The 5500-EZ is a relatively simple two-page form that you can complete yourself using information from your plan’s annual statement and plan documents. You have the option to file it on paper or electronically through the EFAST2 website. Given potential IRS staffing reductions, electronic filing is generally recommended to minimize the risk of your submission getting lost. Electronic filing is mandatory if you file at least 10 returns of any type with the IRS for the plan year, including 1099s, W-2s, employment tax returns, and your income tax return. However, most one-owner operators won’t meet this 10-return threshold.
Dollar Threshold for Filing Form 5500-EZ
You are required to file Form 5500-EZ if your plan’s assets exceed $250,000 at the end of the plan year (December 31 for most plans). If you have multiple one-participant plans, you must file Form 5500-EZ if their combined assets total more than $250,000. In such cases, a separate 5500-EZ must be filed for each plan, even those with less than $250,000 in assets individually.
It can take many years for a plan to reach the $250,000 asset threshold through regular contributions. However, rolling over funds from other retirement accounts can accelerate this process, potentially reaching the threshold sooner than anticipated. Be aware that your plan provider may not explicitly remind you when you cross this $250,000 mark.
Sneaky Form 5500-EZ Final Return Rule
A commonly overlooked requirement is the final return rule. When your 401(k) or other plan has distributed all of its assets to participants and beneficiaries, you must file a final Form 5500-EZ. This means that once you establish a plan, you will trigger at least one 5500-EZ filing, regardless of the asset value. For example, if you open a plan, accumulate $61,000, and then close it, a final 5500-EZ return is required once the $61,000 has been distributed or transferred.
Deadline for Filing
Form 5500-EZ must be filed by the last day of the seventh calendar month after the end of the plan year. For calendar-year plans, this deadline is July 31. It’s crucial to remember that Form 5500-EZ is a separate filing and not submitted with your income tax return.
If you obtain an automatic extension for your income tax return until October 15, your Form 5500-EZ filing deadline is also extended to October 15. If you don’t extend your income tax return, you can still get a two-and-a-half-month extension for Form 5500-EZ by filing Form 5558, “Application for Extension of Time to File Certain Employee Plan Returns,” before the normal due date for Form 5500-EZ.
Penalties for Failure to File Form 5500-EZ
The penalties for failing to file Form 5500-EZ can be substantial: $250 per day, capped at $150,000 for each late 5500-EZ, plus interest. You’ll reach the $150,000 maximum after 600 days. Prior to 2020, the penalty was $25 per day, capped at $15,000 per unfiled return. The plan administrator (you) is directly liable for these penalties.
If you’ve filed Form 5500-EZ in previous years, the IRS anticipates continued filing. Should you fail to file, the IRS may send a CP 403 delinquency notice approximately 15 months after the original due date of the return, at which point your penalty would have already reached $112,500. The CP 403 has a 30-day response requirement. If no timely response is received, the IRS will issue a CP 406 Final Notice 15 weeks later, also with a 30-day response deadline. If the IRS ultimately assesses the penalty, you will receive a CP 283 notice, “Penalty Charged on Your Form 5500 Return.”
If you have never filed a Form 5500-EZ, it might take the IRS several years to discover the oversight, and you may not receive any initial notices. However, when you eventually do receive that notice, the full $150,000 penalty per non-filed return will be applicable.
IRS Late Filer Penalty Relief Program
Fortunately, if the IRS has not yet assessed a penalty and sent a CP 283 penalty notice, you may be able to avoid penalties by utilizing the IRS Late Filer Penalty Relief Program. This is an amnesty program for individuals who have failed to file Form 5500-EZ, and it’s available even if you’ve received a delinquency notice (CP 403 or CP 406).
To qualify for amnesty, you must submit a completed Form 5500-EZ for each delinquent plan year for which you seek penalty relief. Ensure you use the appropriate Form 5500-EZ for the specific year involved (blank forms are available on the IRS website dating back to 1990). Delinquent 5500-EZ returns cannot be filed electronically; they must be submitted on paper to the address specified in the 5500-EZ instructions.
Mark checkbox D, for the “IRS Late Filer Penalty Relief Program,” on Part I of Form 5500-EZ. For years prior to 2020 where checkbox D isn’t present, you must write “Delinquent Return Filed under Rev. Proc. 2015-32, Eligible for Penalty Relief” in red at the top of each paper return. Attach a completed paper copy of Form 14704, the transmittal form, to the front of the oldest late return in your submission. You must also include a check for the filing fee.
The fee is $500 for each delinquent return, up to a maximum of $1,500 per plan. While this is a substantial fee, it is significantly less than the $150,000 per return late filing penalty you could face without amnesty. If you have multiple years of unfiled returns for a single plan, submitting them all in one go will save you money, as the maximum fee remains $1,500 regardless of the number of returns included.
However, if you have more than one one-participant retirement plan for which you’ve failed to file Form 5500-EZ, you must make a separate submission for each plan and pay a separate fee. For instance, if you have both a defined contribution plan and a defined benefit plan and haven’t filed the required Forms 5500-EZ for either plan for three years, you’ll need to file two separate submissions (one for each plan), resulting in a total fee of $3,000.
Reasonable Cause Relief from Form 5500-EZ Penalties
If the IRS has already assessed a late filing penalty and issued a CP 283 penalty notice, you are no longer eligible for the Late Filer Penalty Relief Program. In this scenario, your only option is to request that the IRS remove the penalty for “reasonable cause.”
You can also request reasonable cause relief even if a late filing penalty has not yet been assessed. If your request is granted, you won’t have to pay a fee to the IRS. However, this is a risky approach. If the IRS denies your reasonable cause request, you will no longer qualify for the Late Filer Penalty Relief Program because the penalty for the delinquent return(s) will then be assessed, potentially leading to a staggering penalty. Therefore, you should only pursue reasonable cause relief under these circumstances if you are absolutely confident you meet the strict criteria.
The IRS sets a high bar for reasonable cause relief. Valid reasons for failing to file a 5500-EZ return generally include:
- Fires, natural disasters, or civil disturbances
- Inability to obtain necessary records
- Death, serious illness, incapacitation, or unavoidable absence of the taxpayer or an immediate family member
- Other reasons that demonstrate you exercised all ordinary business care and prudence to meet your filing obligations but were nevertheless unable to do so.
Reasons that typically do not qualify as valid for failure to timely file your 5500-EZ include:
- Reliance on a tax professional
- Lack of knowledge regarding the filing requirement
- Simple mistakes or oversights (unless additional facts and circumstances indicate an attempt to comply)
If you have received a CP 283 penalty notice, you can call the number on the notice and request reasonable cause relief over the phone. If your request is denied, or if you prefer not to use the phone, you can formally request relief in writing by filing Form 843, “Claim for Refund and Request for Abatement.” In the form, clearly explain the facts and circumstances surrounding your late 5500-EZ return, including:
- What happened and when it occurred
- How the situation prevented you from filing your 5500-EZ return
- What attempts you made to file
You should also include supporting documentation, such as:
- Hospital records, court records, or a doctor’s letter confirming illness or incapacitation (with start and end dates)
- Documentation of natural disasters or other disturbances
- Copies of relevant written correspondence and responses
- Copies of forms or other pertinent documentation
If a penalty has not been assessed or you haven’t received a CP 283 penalty notice, you can request reasonable cause relief by attaching your request to a delinquent 5500-EZ return when you file it, or you can file the Form 5500-EZ and the request for reasonable cause separately. Your request should clearly state the reason for the late return and must be signed. Include documentation that supports your request for relief and mail it to the filing address provided in the instructions for the most current Form 5500-EZ.
If your request for reasonable cause relief is denied, you have the right to appeal by requesting an IRS Independent Office of Appeals conference or hearing.
Key Takeaways
- You are required to file at least one IRS Form 5500-EZ if you have a one-participant retirement plan. This includes plans covering only a business owner (and spouse) or partners (and their spouses) of a business partnership.
- You must file Form 5500-EZ if your plan’s assets exceed $250,000 at the end of the plan year.
- A final Form 5500-EZ must be filed when your plan ends and all of its assets have been distributed or transferred to participants and beneficiaries.
- Failure to file Form 5500-EZ can result in a penalty of $250 per day, capped at a maximum of $150,000 per return.
- If the IRS has not yet assessed a penalty, you can often avoid penalties through the IRS Late Filer Penalty Relief Program. This involves filing all past-due Form 5500-EZ returns and paying a fee of $500 per return, with a maximum fee of $1,500 per plan.
- The Late Filer Penalty Relief Program is not available if the IRS has already assessed a late filing penalty. In such cases, your only recourse is to attempt to get the IRS to remove the penalty for reasonable cause. Grounds for reasonable cause include natural disasters, inability to obtain records, serious illness or death, or other reasons demonstrating that your failure to file was not due to a lack of ordinary business care and prudence.
- While plan administrators can also seek reasonable cause relief if a late filing penalty has not been assessed (potentially avoiding a fee), this is risky. If the IRS denies the request, the penalty will be assessed, and you will no longer qualify for the Late Filer Penalty Relief Program.
