Owners and partners can participate in a 401(k) plan with self employment income. When owners and partners make a 401(k) contribution from their self-employment income based on reasonable income estimates, which is called an Owner's Draw contribution, their annual 401(k) contributions can be projected in terms of compliance testing for the plan. However, where income cannot be accurately projected or owners choose not to make regular Owner's Draws, it is difficult to create accurate projections for compliance testing purposes. This can lead to testing failures and costly corrections for sponsors.
Similarly, some owners of C-corporations pay themselves large year-end bonuses based on estimated earnings. The use of such bonuses makes a forward-looking analysis of compliance testing much more difficult.
If your business is a passthrough entity and does not make regular Owner's Draws, or your business pays a large portion of compensation in year-end bonuses which owners or highly compensated employees intend to put toward their 401(k) account contributions, consider providing regularly updated estimates of annual owner/partner income in Guideline. Alternatively, you may wish to choose a Safe Harbor plan design so that backloaded contributions will not result in your plan failing nondiscrimination testing.