Setting up an Individual 401K Properly

[ConsistentEffortWins]

I recently discovered I would stand to benefit from establishing an individual 401k for my side business. This side business started growing this year so I am preparing to formalize it as more than a hobby business.

I wanted to see if I understand the steps correctly and if there is any advice in regards to how to best set up an i401K.

For context, this business generates roughly 4-6K a month, with an 80%-85% margin.

Here is what I understand I need to do:

1. Establish a LLC and register for an EIN.
2. Open a business checking account under the LLC and separate personal vs. business expenses
3. Open an individual 401K with Vanguard (I have a Roth with them, so I will be sticking to Vanguard unless there are significant advantages to other brokers?)

This is where I'm not sure about step 4: If I'd like to max out my employee portion as a sole proprietorship LLC, do I simply fund the i401K from the business checking account until I reach $18,000? Or do I first send the money to my personal checking and fund it from there?

Then am I correct in my understanding that I can do an employer match of 25% of profit? My understanding here is that it comes from the business checking.

How does all this influence my schedule C if I continue to elect to be treated to be taxed as a sole proprietor? Do I just deduct all my i401K contributions on Line 28?

For those of you with LLCs electing to be S-Corps, have you found the tax advantages to be worth the additional set up in regards to payroll? I'd prefer doing this without an accountant so I'd love to hear about how you went about setting up the S-Corp if you did it yourself. What is a reasonable salary for payroll when your business does not gross over six figures a year?

Thank you very much!

[dandarc]

If you are organized / taxed as an S-Corp, then the 25% employer-side is of your W-2 earnings, not of your total profits.

Otherwise I think you've got it.

If you are a sole-proprietor, then your employer limit is 20% of your net, less 1/2 self-employment taxes.  To save some head-scratching, this is equivalent to an S-Corp where you bonus yourself out so that you've got exactly 0 "profits" at year end.

So long story short, how you choose to organize doesn't effect your Solo401K contribution limits.  Except if you go S-Corp, you're likely doing so so that you can pay yourself a lower salary than the total profits of the business and so save on self-employment taxes.  Since in that case, you're lowering your W-2 from what you could do, that would lower your Solo401K limits.  But that isn't because you're an S-Corp, it is because of how you choose to compensate yourself from said S-Corp.

And it really doesn't matter where the money comes from either.  You'd probably want to pay everything from your business account for organization purposes, but you don't have to have a separate business checking account.

[ConsistentEffortWins]

So something I've started doing is using an older checking account for all the side business related transactions. I still have payments go to my personal though; I've read around that it is good practice to separate the business from personal. Would there be potential issues in keeping it the way I have it set up?

Thank you for the clarification on S-Corps.

[dandarc]

As long as you keep track of it all, it really doesn't matter.  There is no legal requirement that says you have to have separate checking accounts for your business. 

I personally don't bother - I have less than 50 transactions / year for my business - maybe 15 revenue events and 20-30 expenses.  I just mark them as they come through as business so I can double-check my records come tax-time.

[protostache]

So something I've started doing is using an older checking account for all the side business related transactions. I still have payments go to my personal though; I've read around that it is good practice to separate the business from personal. Would there be potential issues in keeping it the way I have it set up?

Thank you for the clarification on S-Corps.

You should follow through with your plan and open separate accounts with your EIN. The more you mix funds, the less you look like a business. Single-member LLCs are a somewhat fragile legal construct in the event you get sued, so the more you look like a real business the better.

One thing to keep in mind is that employee contributions count as wages subject to FICA/Social Security taxes. If you're going to be set up as an LLC S-Corp, then I would recommend sending the employee portion through whatever payroll system you use to make sure everything is withheld properly. I personally pay ZenPayroll to handle my payroll, which I set up without an accountant. I've also heard very good things about Wagepoint but I haven't used them myself. Either way, it's money well spent to not have to deal with filling forms every month.