Author Topic: Solo 401k - Accountant says contributing will actually raise my taxes?  (Read 6479 times)

jsloan

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Hi Everyone,

I'm having trouble understanding solo 401Ks and the tax implications.  As some background, I work full-time for a consulting company as an employee (benefits, etc) and my wife and I co-own a small consulting company (side business).  I currently earn around 110K in my day job, and currently max out my 401K and IRA (Roth).  My wife also contributes to a traditional IRA.  Currently the only employees of the LLC are my wife (owner) and I (employee) although we sometimes have paid other consultants for larger jobs, but none this year so far.  The part-time business usually earns around 50K-65K per year gross (We have very little overhead since it is software consulting).  We also own a rental that brings in about 18K per year (net probably 2000K, not great).  Because of this we have worked with an accountant that setup the business to pay taxes quarterly as part of the LLC, my wife is also paid a "salary" in this setup for payroll purposes.  We also take the usual deductions on the rental for depreciation, write-offs, etc. 

Last year we opened a Vanguard solo 401K for the business towards the end of the year, and decided to start small and add 5500.00 to it.  After doing this we called our accountant and told him, but he was kind of pissed that we didn't ask him first and we ended up paying more in taxes due to the way the business was structured.  He said something about the amount of taxes we pay quarterly were not setup for a solo 401K contribution so it was going to cause issues at the end of the year.  At the end of the year he was right and we had an additional tax bill for around $700.00 that we would not have had otherwise if we would have just invested the money in a taxable account (I'm assuming?).

I'm having trouble understanding how this could be the case?  I just figured if we contributed more money to the individual 401K that it would mean we would pay less taxes per year because our taxable income would be less.  Does anyone know why this would have happened?

Thanks in advance!

forummm

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I'm puzzled too. If there were extra tax due, you probably could have recharacterized it and not owed the extra tax.

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At the end of the year he was right and we had an additional tax bill for around $700.00 that we would not have had otherwise if we would have just invested the money in a taxable account (I'm assuming?).

Sounds like the accountant didn't actually tell you this. It could have been that you would have owed $700 anyway (as often happens) or that it would have been even more without the 401k deduction.

Did you look at your tax forms that you filed? That's where I would start.

Jack

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I'm not an accountant, but it sounds to me like you overcontributed. The limit is the total across all your 401Ks, not per account. By maxing it at your primary job, you became ineligible to contribute at your second job.

If I'm not mistaken, you could have a solo 401K for your second job and contribute more to it (i.e., contribute the normal $18K plus 20% of [second job earned income - $18K], I think), but then you become ineligible to participate in your primary job's 401K.

I don't know if it's allowed to do the "optimal" thing and contribute from both, e.g., up to the company match at the primary job, then maxing the rest from the solo -- you'd have to ask your accountant about that.

jsloan

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So I looked up some of the emails I had with our accountant and he said that since we contributed money to our solo 401K that this showed that we made more income than originally claimed so we had to adjust our earnings up and thus we would need to pay more in social security tax since this is not exempt from solo 401ks?  Does this sound correct? 

MDM

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I'm not an accountant, but it sounds to me like you overcontributed. The limit is the total across all your 401Ks, not per account. By maxing it at your primary job, you became ineligible to contribute at your second job.

If I'm not mistaken, you could have a solo 401K for your second job and contribute more to it (i.e., contribute the normal $18K plus 20% of [second job earned income - $18K], I think), but then you become ineligible to participate in your primary job's 401K.

I don't know if it's allowed to do the "optimal" thing and contribute from both, e.g., up to the company match at the primary job, then maxing the rest from the solo -- you'd have to ask your accountant about that.

+1

E.g., see http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-401k-and-Profit-Sharing-Plan-Contribution-Limits.

And yes, start by reviewing all the submitted tax forms to develop your own understanding, then talk with the accountant to get the full picture.

MDM

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So I looked up some of the emails I had with our accountant and he said that since we contributed money to our solo 401K that this showed that we made more income than originally claimed so we had to adjust our earnings up and thus we would need to pay more in social security tax since this is not exempt from solo 401ks?  Does this sound correct?
Yes, as far as it goes.  See http://www.irs.gov/Retirement-Plans/Retirement-Plan-FAQs-Regarding-Contributions-Are-Retirement-Plan-Contributions-Subject-to-Withholding-for-FICA-Medicare-or-Federal-Income-Tax.

But you should be over the SS (not Medicare) maximum anyway, given the incomes listed in the OP.  See http://www.irs.gov/taxtopics/tc751.html.

Read your tax returns....

jsloan

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Quote
I'm not an accountant, but it sounds to me like you overcontributed. The limit is the total across all your 401Ks, not per account. By maxing it at your primary job, you became ineligible to contribute at your second job.

If I'm not mistaken, you could have a solo 401K for your second job and contribute more to it (i.e., contribute the normal $18K plus 20% of [second job earned income - $18K], I think), but then you become ineligible to participate in your primary job's 401K.

I don't know if it's allowed to do the "optimal" thing and contribute from both, e.g., up to the company match at the primary job, then maxing the rest from the solo -- you'd have to ask your accountant about that.

I think you may be correct, we thought that since my wife was the owner of the LLC that it would not matter what I contributed in my day job and the contributions would be for her alone.  In subsequent emails it looks like he is talking about removing me from the LLC as an employee to avoid confusion about the 401K contributions.  Since all our taxes were lumped together there must have been something about me already hitting my contribution limits.  Thanks for all your help, this is starting to make sense :-).   

jsloan

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Yes, as far as it goes.  See http://www.irs.gov/Retirement-Plans/Retirement-Plan-FAQs-Regarding-Contributions-Are-Retirement-Plan-Contributions-Subject-to-Withholding-for-FICA-Medicare-or-Federal-Income-Tax.

But you should be over the SS (not Medicare) maximum anyway, given the incomes listed in the OP.  See http://www.irs.gov/taxtopics/tc751.html.

Read your tax returns....

In regards to this, I bet he was pissed because this meant he had to redo a lot of the tax calcs he had already done not knowing that we had opened this account.  I doubt he cared if we had to pay more taxes, he probably just didn't want to redo our returns :-). 

Counting_Down

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So I looked up some of the emails I had with our accountant and he said that since we contributed money to our solo 401K that this showed that we made more income than originally claimed so we had to adjust our earnings up and thus we would need to pay more in social security tax since this is not exempt from solo 401ks?  Does this sound correct?

So this sounds to me that he under claimed your earnings from you side business, thus reducing your quarterly tax payments.  He was probably pissed because your contribution put him in a position where he had to adjust this potentially at the scrutiny of the IRS.  He is legally responsible for accurate preparation of your taxes, and could go to jail for misrepresentation.  Sounds like the issue was more with his reporting than your solo 401k.  Everyone hates to pay taxes, but I would have a serious talk with him about how this occurred and if he has been taking some artistic leeway with your side income in the past.  We all hope our tax guys do some magic and know the rules to levy to get our tax bill as low as possible...  However; outright lying is a BFD and you wouldn't want to get caught up in the fallout if the IRS ever caught it - since you should be looking over your returns, you should know if he's being above board.

Good luck!

Candace

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So I looked up some of the emails I had with our accountant and he said that since we contributed money to our solo 401K that this showed that we made more income than originally claimed so we had to adjust our earnings up and thus we would need to pay more in social security tax since this is not exempt from solo 401ks?  Does this sound correct?

Sounds like this has to do with the classification of the money between dividends paid to you by the company (not subject to payroll taxes including SS), and salary (obviously subject to SS), and profit-sharing contributions to your Solo 401(k). It's been a few years since I dealt with this, but the amount you can contribute to your Solo 401(k), while potentially substantial, is limited by a few rules. The employee can withhold up to $18k across this 401(k) and their other plans, as noted above. The company can make a profit-sharing contribution, which is limited up to 25% of your salary, but is separate from your salary. I think it's a business expense. The total amount in your account between the profit-sharing contribution and the employee's withholding is subject to some large limit like $53k. I'm not sure how the limits apply when you have a Solo 401(k) and a "normal" 401(k) that you can only contribute $18k to.

So if the accountant felt he had to classify your contribution as salary withholding for whatever reason, then depending on the amount of income he classified as salary versus a dividend paid to you by the company could affect your payroll taxes including Social Security. The dividend is not subject to payroll taxes, but salary is.

This is obviously very confused, but the upshot is that depending on how the money going into your Solo 401(k) is classified, and how your accountant had things set up between salary, dividend and profit-sharing, you could have messed up his or her intended plan for how things should go. However, it is your money, and your accountant should be able to chat with you about a way to go forward that maintains your control at the same time as you are aware of his or her plan.

jsloan

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Quote
Sounds like this has to do with the classification of the money between dividends paid to you by the company (not subject to payroll taxes including SS), and salary (obviously subject to SS), and profit-sharing contributions to your Solo 401(k). It's been a few years since I dealt with this, but the amount you can contribute to your Solo 401(k), while potentially substantial, is limited by a few rules. The employee can withhold up to $18k across this 401(k) and their other plans, as noted above. The company can make a profit-sharing contribution, which is limited up to 25% of your salary, but is separate from your salary. I think it's a business expense. The total amount in your account between the profit-sharing contribution and the employee's withholding is subject to some large limit like $53k. I'm not sure how the limits apply when you have a Solo 401(k) and a "normal" 401(k) that you can only contribute $18k to.

So if the accountant felt he had to classify your contribution as salary withholding for whatever reason, then depending on the amount of income he classified as salary versus a dividend paid to you by the company could affect your payroll taxes including Social Security. The dividend is not subject to payroll taxes, but salary is.

This is obviously very confused, but the upshot is that depending on how the money going into your Solo 401(k) is classified, and how your accountant had things set up between salary, dividend and profit-sharing, you could have messed up his or her intended plan for how things should go. However, it is your money, and your accountant should be able to chat with you about a way to go forward that maintains your control at the same time as you are aware of his or her plan.

Ok, this is starting to make sense.  We do pay payroll quarterly along with the subsequent taxes.  Thanks for the great reply!  Is there any advantage to being paid via dividend versus payroll?  I guess I don't understand the difference?

BarkyardBQ

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Not trying to hijack the thread but this is a relevant question for me as I'm looking into opening a small business to utilize s401k space. If I have a 403b, and a Solo 401k, am I only allowed to contribute 18000 total? I have been under the assumption that s401k contributions were calculated separate from other 403/401k contributions.

If that's the case, can I still have a 403b, and have only the company contribute to the s401k?
« Last Edit: July 17, 2015, 12:12:14 PM by zdravé »

MDM

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Not trying to hijack the thread but this is a relevant question for me as I'm looking into opening a small business to utilize s401k space. If I have a 403b, and a Solo 401k, am I only allowed to contribute 18000 total? I have been under the assumption that s401k contributions were calculated separate from other 403/401k contributions.

If that's the case, can I still have a 403b, and have only the company contribute to the s401k?

Read http://www.irs.gov/Retirement-Plans/How-Much-Salary-Can-You-Defer-if-You%E2%80%99re-Eligible-for-More-than-One-Retirement-Plan%3F for more details but the short version:
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The amount of salary deferrals you can contribute to retirement plans is your individual limit each calendar year no matter how many plans you're in. This limit must be aggregated for these plan types:

    401(k)
    403(b)
    SIMPLE plans (SIMPLE IRA and SIMPLE 401(k) plans)
    SARSEP

If you’re in a 457(b) plan, you have a separate limit that includes both employee and employer contributions.

BarkyardBQ

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Thanks MDM.

oldmannickels

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Assuming the Solo 401(k) was in your wife's name this contribution would not be over the limit.

It sounds like the LLC was set up an as S-Corp and your wife was taking a salary from the S-Corp. He had to add the 401(k) contributions to your wife's salary resulting in additional S/E taxes. Depending on when you made the contribution and when you told him about the contribution this would likely result and amending quarterly payroll tax returns and adding to it any fees. While this did lower your Fed Tax it raised your FICA tax.


jsloan

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Quote
It sounds like the LLC was set up an as S-Corp and your wife was taking a salary from the S-Corp. He had to add the 401(k) contributions to your wife's salary resulting in additional S/E taxes. Depending on when you made the contribution and when you told him about the contribution this would likely result and amending quarterly payroll tax returns and adding to it any fees. While this did lower your Fed Tax it raised your FICA tax.

So based on our current setup is better to just invest in after-tax accounts?  It seems stupid to invest 5500 and have 700.00 immediately go to taxes.

Papa bear

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Assuming the Solo 401(k) was in your wife's name this contribution would not be over the limit.

It sounds like the LLC was set up an as S-Corp and your wife was taking a salary from the S-Corp. He had to add the 401(k) contributions to your wife's salary resulting in additional S/E taxes. Depending on when you made the contribution and when you told him about the contribution this would likely result and amending quarterly payroll tax returns and adding to it any fees. While this did lower your Fed Tax it raised your FICA tax.

+ 1   Probably exactly what happened.  I highly doubt your accountant was evading taxes and he was only practicing tax avoidance, which is perfectly legal.


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forummm

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I think you can have $0 salaries for you and your wife, but still make employer contributions to solo 401k's for the both of you. You just have to make the same contributions to each employee (even if $0 salary). And the employer contributions don't count towards your individual contribution limit. But you could also pay your wife a salary of $18k and just have it go straight to the 401k. Her salary would be FICA taxable.

But check with your accountant.

Candace

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I think you can have $0 salaries for you and your wife, but still make employer contributions to solo 401k's for the both of you. You just have to make the same contributions to each employee (even if $0 salary). And the employer contributions don't count towards your individual contribution limit. But you could also pay your wife a salary of $18k and just have it go straight to the 401k. Her salary would be FICA taxable.

But check with your accountant.

My recollection is that the employer contribution is limited to 25%of salary. Therefore there would have to be a salary, which is subject to FICA.

I'm sure there are some good websites that have all the information.

http://www.irs.gov/Retirement-Plans/One-Participant-401%28k%29-Plans

dandarc

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Quote
It sounds like the LLC was set up an as S-Corp and your wife was taking a salary from the S-Corp. He had to add the 401(k) contributions to your wife's salary resulting in additional S/E taxes. Depending on when you made the contribution and when you told him about the contribution this would likely result and amending quarterly payroll tax returns and adding to it any fees. While this did lower your Fed Tax it raised your FICA tax.

So based on our current setup is better to just invest in after-tax accounts?  It seems stupid to invest 5500 and have 700.00 immediately go to taxes.
If the assumption above is right, you paid maybe 15.3% in additional payroll taxes.  What is your marginal tax rate?  You still may have come out ahead here - if you're in the 25% bracket for federal income tax, for example.  And that extra social-security tax buys you more social security benefits down the road, so it is not like you're getting nothing for it.

You might try and do the taxes yourself one of these years.  Will help you know how all this stuff interrelates to actually do the work and fill the forms in yourself.  These need not be the forms you necessarily send in, but it will be very educational.

dandarc

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I'm thinking what actually happened is this:

1.  You started the soloK before the end of 2014, as required.
2.  You didn't properly "declare" the deferral from the wife's salary before the end of 2014.
3.  You actually deposited the money in early 2015.  Because it wasn't declared or deposited during 2014, this has to be an employer contribution.
4.  Employer contributions are capped at 25% of your W-2 salary.  So between you and your wife, you've got to have $25K or so of salary income to make this contribution.

If her W-2 was actually for say $10K or $15K, then you've got a bunch more income, only partially offset by the 401K contribution.


The "correct" way, for the situation as described for this year would be to do this:

Deposit whatever you are going to into your wife's account as an Employee deferral before the end of the year.  You'll still need to have enough salary to support this, but then you're matching the required income much more closely to the deferred amount.

AlwaysLearningToSave

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Assuming the Solo 401(k) was in your wife's name this contribution would not be over the limit.

It sounds like the LLC was set up an as S-Corp and your wife was taking a salary from the S-Corp. He had to add the 401(k) contributions to your wife's salary resulting in additional S/E taxes. Depending on when you made the contribution and when you told him about the contribution this would likely result and amending quarterly payroll tax returns and adding to it any fees. While this did lower your Fed Tax it raised your FICA tax.

+ 1   Probably exactly what happened.  I highly doubt your accountant was evading taxes and he was only practicing tax avoidance, which is perfectly legal.


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+ 2. It's easy to focus just on income taxes and overlook total tax burden. I bet this is what happened.

maizeman

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Not trying to hijack the thread but this is a relevant question for me as I'm looking into opening a small business to utilize s401k space. If I have a 403b, and a Solo 401k, am I only allowed to contribute 18000 total? I have been under the assumption that s401k contributions were calculated separate from other 403/401k contributions.

If that's the case, can I still have a 403b, and have only the company contribute to the s401k?

The 18k limit is per person across all 401k and s401 and 403b accounts. However, as long as your day job and your side business have clearly legally separate ownership, you have separate 53k per employer limits for each account. So having the small business and s401k means you can save 20% of your small business income (up to a total of 53k) on top of maxing out your account at work.

dandarc

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Not trying to hijack the thread but this is a relevant question for me as I'm looking into opening a small business to utilize s401k space. If I have a 403b, and a Solo 401k, am I only allowed to contribute 18000 total? I have been under the assumption that s401k contributions were calculated separate from other 403/401k contributions.

If that's the case, can I still have a 403b, and have only the company contribute to the s401k?

The 18k limit is per person across all 401k and s401 and 403b accounts. However, as long as your day job and your side business have clearly legally separate ownership, you have separate 53k per employer limits for each account. So having the small business and s401k means you can save 20% of your small business income (up to a total of 53k) on top of maxing out your account at work.
I'll elaborate just a bit more - if you are happy with your work 401K/403B, you could do your 18K employee deferral there, then use a SEP-IRA for your side business.  Somewhat simpler to deal with than a SoloK, and you can defer the same amount in that scenario.