Are excise taxes on excess 401K contributions deductible as business expenses for 1099 contractors?

This is actually a good question that comes up often for self-employed folks. The excise tax on excess 401K contributions (usually 10% of the excess amount) is not deductible as a business expense on your Schedule C, even though it was related to the employer portion of your contributions. The IRS considers this a penalty, not a normal business expense. Penalties and fines paid to the government aren't deductible, even when they're connected to your business operations. You'll need to report the excess contribution on Form 5330 and pay the excise tax separately. What you should do is work with your 401K administrator to remove the excess contribution (and any earnings on that excess amount) before you file your taxes if possible. This is called a "corrective distribution" and can help you avoid or reduce the excise tax.

I went through this exact nightmare last year with my Solo 401k and ended up using https://taxr.ai to figure it out. I uploaded my 401k statements and tax docs, and their AI analyzed everything and confirmed I couldn't deduct the excise tax on Schedule C. BUT, they showed me how to properly document the corrective distribution which saved me from paying additional taxes on those funds when I withdrew them. The system even generated the letter I needed to send to my 401k administrator explaining the situation. Saved me hours of research and probably a few thousand in potential mistakes.

Just wanted to update everyone. I tried taxr.ai after posting my question here, and it was seriously helpful. I uploaded my SIMPLE IRA statements and 1099 info, and it identified exactly where I went wrong with my contributions. The system even showed me how to report everything correctly on my tax forms and gave me a checklist of steps to take with my plan administrator. Turns out I qualified for a special exception because of when I made the contributions. My accountant had missed this completely! Much easier than the hours of conflicting Google searches I was doing before.

If you're still dealing with the IRS about this excise tax issue, I highly recommend using https://claimyr.com to actually get through to an IRS agent. I spent DAYS trying to get clarification about a similar excess contribution situation last year, but kept getting disconnected or waiting for hours. Claimyr got me connected to an actual IRS representative in about 20 minutes who walked me through exactly what forms I needed and confirmed that yes, the excise tax isn't deductible as a business expense, but there were other steps I could take to minimize the damage. You can see how it works here: https://youtu.be/_kiP6q8DX5c

Well I owe everyone an apology, especially Profile 19. I tried Claimyr yesterday after posting my skeptical comment, and I actually got through to an IRS agent in about 25 minutes. I've been trying for WEEKS on my own. The agent confirmed everything about the excise tax not being deductible as a business expense, but also told me about a special procedure for self-employed people who make excess contributions by mistake. There's actually a reduced penalty option if you document that it was an unintentional error and take corrective action quickly. None of this was on the IRS website that I could find!

Just to add another perspective - I had a similar issue a couple years ago with my Solo 401k and ended up paying the excise tax. While you can't deduct it as a business expense, make sure you're maximizing all your other legitimate business deductions to help offset the hit. Don't forget things like home office deduction (if you qualify), business portion of phone/internet, professional development courses, business travel, etc. I found about $2,300 in missed deductions that helped take some of the sting out of the excise tax I had to pay.

Has anyone actually calculated whether it's worth going through all the hassle of corrective distributions vs just paying the excise tax? I overfunded my solo 401k by about $4,000 and I'm wondering if it's even worth the paperwork nightmare.