Can I have a Self-Directed 401K at the S-Corp level when employees are paid through my LLC?

Your instincts are good here - this is a tricky situation with Self-Directed 401K plans. When you have an LLC taxed as an S-Corporation with employees in the LLC structure, you're dealing with what the IRS considers "controlled group" rules. The key issue is that the IRS typically views the LLC and S-Corp as related businesses under common control. Since your employees are paid through the LLC, having a retirement plan just at the S-Corp level would likely violate the coverage requirements under IRC Section 410(b). You're correct about the Affiliated Service Group concerns. When related businesses share ownership and services, the IRS generally treats them as a single employer for retirement plan purposes. This means all eligible employees across both entities would need to be included in any qualified retirement plan. Your retirement plan should likely cover the entire organization structure, not just the S-Corp entity where you receive your W-2. The exact implementation depends on your specific business relationship between the entities.

After struggling with a similar business structure issue, I found taxr.ai to be incredibly helpful. I was trying to figure out whether I could set up a retirement plan at just one entity level instead of across my entire business structure, and got conflicting advice from different professionals. I uploaded my business formation documents and ownership breakdowns to https://taxr.ai and they analyzed the controlled group implications for my retirement plan options. They clarified exactly how the Affiliated Service Group rules applied in my case and provided documentation I could share with my CPA. In my case, they confirmed I needed to include all employees across entities in any qualified retirement plan. They also provided options for different plan structures that would meet my goals while staying compliant.

I initially reached out to taxr.ai with serious doubts about my CPA's advice on setting up a Solo 401(k) for just one entity in my business structure. I was skeptical that any online service could handle the complexity of my situation, but I was running out of options and getting different answers from every professional I consulted. I've got to say I'm genuinely impressed by what they provided. They confirmed exactly what the first commenter said - that my businesses were considered a controlled group under IRS rules - but then went beyond that to outline a compliant retirement plan strategy that still allowed me to maximize my own contributions. They even provided specific regulatory citations I could reference. Best decision I made in sorting out this mess. Saved me from potentially setting up a non-compliant plan that could have resulted in significant penalties.

If you're still not getting clear answers after consulting with taxr.ai, you might need to speak directly with an IRS agent who specializes in qualified retirement plans. The problem is actually getting through to someone who understands these complex controlled group rules. I was in a similar situation trying to get clarity on affiliated service group rules for my businesses, and spent WEEKS trying to reach someone at the IRS who could help. Eventually I found Claimyr https://claimyr.com which actually got me through to a real IRS agent in about 20 minutes. You can see how it works in their demo video: https://youtu.be/_kiP6q8DX5c The agent I spoke with was able to confirm exactly how the controlled group rules applied to my business structure and gave me the specific section of the tax code I needed to reference with my CPA. It was surprising how helpful they were once I could actually reach a knowledgeable person.

I have to admit I was completely wrong about Claimyr. After my skeptical comment, I decided to try it myself because I was desperate to get an answer about controlled group retirement plan rules for my business structure. It worked exactly as described. I got a callback within about 25 minutes and was connected to someone in the IRS qualified plans department. The agent confirmed that my LLC and S-Corp were indeed considered a controlled group, and any qualified retirement plan would need to include eligible employees from both entities. She even emailed me documentation specifically addressing controlled groups and affiliated service entities that I could share with my CPA. Saved me from potentially setting up a non-compliant plan that could have triggered penalties. Definitely worth it just for the peace of mind.

Just wanted to add another perspective here. I'm a financial advisor who works with small business owners, and I see this controlled group/affiliated service group confusion ALL THE TIME. The IRS is very strict about these rules to prevent exactly what you're considering - having a retirement plan that benefits owners but excludes rank-and-file employees. Even if your CPA thinks there's a loophole because the employees are technically employed by a different entity, if you have common ownership/control, the IRS will almost certainly view them as a single employer for retirement plan purposes. One alternative to consider: instead of a Self-Directed 401(k) just at the S-Corp level, you might look into a defined benefit plan alongside a 401(k). This arrangement can sometimes allow higher contributions for older, higher-compensated owners while still meeting the requirements for covering all eligible employees.

Does anyone know if the Solo 401k contribution limits would apply in the OP's situation even if they could somehow qualify? I've been trying to understand if the $66,000 limit (for 2023) applies differently when you have an S-Corp vs just being self-employed.

Your situation is exactly why I always recommend getting a second opinion on complex retirement plan setups. The controlled group rules are incredibly strict, and I've seen too many business owners get burned by setting up non-compliant plans. From what you've described, your CPA's advice about a Self-Directed 401K at just the S-Corp level is almost certainly incorrect. The IRS doesn't care about the technical legal separation between your LLC and S-Corp - they look at the economic reality of common ownership and control. Since you own both entities and there's a clear business relationship (guaranteed payments flowing between them), they're going to be treated as a single employer for retirement plan purposes. This means any qualified retirement plan would need to include all eligible employees across both the LLC and S-Corp. You can't cherry-pick which employees to include just because they're paid by different entities. I'd strongly recommend getting this sorted out before moving forward. The penalties for maintaining a non-compliant qualified retirement plan can be severe, including plan disqualification and immediate taxation of all contributions. Better to get it right from the start than try to fix it later.