Rolling over funds from a traditional IRA into an Individual 401(k) to avoid the pro-rata rule

Question

I expect that in 2022, my income will exceed the deduction limits for a traditional IRA, so any contributions I make to it will be non-deductible. My understanding is that once I make a non-deductible contribution to my traditional IRA, I could, in the future, be subject to the pro rata rule.
However, 401(k) plans, including traditional Individual 401(k) plans, don't seem to be subject to the pro-rata rule. Can I follow this process to avoid the pro rata rule in the future?

Apply for a federal EIN as a sole proprietor.
Use that EIN to set up an Individual 401(k) plan at a place like Vanguard
Roll over all of the funds in my current traditional IRA (which, as of now, are all pre-tax) into the traditional Individual 401(k)

This seems like a "too good to be true" loophole in the pro rata rule. It sounds very clever but my default assumption is that it's either wrong or that the IRS is considerably more clever than me googling things. Even though my sole proprietorship wouldn't have any income (because I'm a W2 employee for my actual employer), rollover contributions aren't subject to the $57K annual contribution limit.

Dilip Sarwate · Accepted Answer

You can set up a Solo 401(k) Plan if you wish and roll over all your Traditional IRA money (all of which is pre-tax) into it if the plan allows it, but any 401(k) contributions into your Solo 401(k) Plan must come from self-employment income, not from your W2 income or investment income. If you contribute any cash into the Solo 401(k), the IRS will assume that it came from self-employment income, and look to collect SS and Medicare taxes on the self-employment income. If the plan says that you are limited to 15% salary or $19,500 whichever is smaller and you contribute $6K (same as IRA limit), that $6K can be presumed to be 15% of your self-employment income and bingo, you owe income tax on $40K of presumed self-employment income plus employer's share of SS tax (assuming your W2 wages have passed the employee limit for SS withholding) plus employer and employee share of Medicare tax etc.
I am not sure all this is worth the avoidance of the pro rata rule, but obviously, ymmv.

Rolling over funds from a traditional IRA into an Individual 401(k) to avoid the pro-rata rule

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