Author Topic: Take the test. Self Employed retirement account scenario. What would you do?  (Read 5060 times)

Money Stoic

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Your choices are: 

SEP
Simple
Individual 401k
Individual ROTH 401k




Using hypothetical figures, let's say your LLC entity has 30,000 in taxable income after expenses.   What is the minimum you can pay yourself and stay in the good graces of the IRS (what you pay yourself incurs a 16.8% pay roll tax hit, which is bad) if you optimize what you put in a tax deferred retirement account?

It looks like the Vanguard Individual 401k is the way to go in this case.

https://investor.vanguard.com/what-we-offer/small-business/compare-plans?Link=facet

Here is what I would do: 

It looks like I can put in $17,500 on my personal end (and avoid pay roll taxes?) and my LLC can put in up to $52,000 for me and get a 25% deduction.

So, of the $30,000, I should send $17,500 to the 401k. 

That leaves $12,500 of taxable income.   

I would then just have to pay myself $12,500 as an employee.

If I didn't need the money, I could put another $10,000 more into the 401k and get another $2500 tax deduction.  I now just owe pay roll taxes AND regular earned income taxes on $10,000 for the year.

Have I optimized it?  What would you do?

Ready...go...

simplified

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The maximum the business can contribute and get a deduction is on 25% of your gross wages. So if you pay yourself 24k, the business can contribute 6k. That will use up the 30k. You defer 17.5k of the 24k and pay taxes on the 6.5k.

There is no problem in doing this as far as IRS is concerned.

ROTH 401k is for high net worth individuals, who expect to be in higher or same bracket during retirement as now.

bacchi

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And the 25% is for corporations, not LLCs (unless it's acting as a corporate LLC). For pass-through LLCs, the profit share % is smaller.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/LLC-Filing-as-a-Corporation-or-Partnership

Similarly, you'll owe pay roll taxes on the entire earned amount if it's a pass-through LLC.

JGB

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Similarly, you'll owe pay roll taxes on the entire earned amount if it's a pass-through LLC.

Quoted for emphasis. In previous years, I thought that sticking the majority of side-business income for myself and my wife into a solo 401k would be a tax-free endeavor, but at tax time, we found we owed a few grand from FICA/self-employment/social taxes even if we put everything we made into the 401k. And our lack of payments throughout the year left us with a minor penalty as well.

Money Stoic

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...and if the LLC had an S-Corp election, the Solo 401k would be funded with business side dollars and not subject to FICA etc...correct?  I.E...those funds would not be part of what you paid yourself, correct?

So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.

Money Stoic

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ROTH 401k is for high net worth individuals, who expect to be in higher or same bracket during retirement as now.

However, the smart money is that tax rates / brackets will be MUCH higher in 25 years (my amount of time until being able to access the funds without penalty) as we figure out a way to pay for socialized health care. 

So, putting as much as you can in a ROTH now will mean avoiding the higher rate later even if your income is less than it is now (less income + creep of the tax rate still = higher taxes if the creep is as big as I think it will be...help us out here Canada folks...what are your tax brackets these days?).

BlueHouse

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So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.
There is a lot more paperwork with any type of corp than with an LLC or sole proprietorship.  I am pretty detail oriented and didn't think I'd mind the extra paperwork when I signed up as an S-Corp.  6 years later, and I wish I had simplified things. 
It's not a huge deal, but when I moved into another state/got an out-of-state contract, the other state requires S-corporations to pay income tax (yeah, I didn't know that was a thing when I signed up as an S-Corp).  So I pay a small amount of corporate tax to DC and then credit the tax paid on my personal return...it's a pain.  Personally, if I weren't willing to pay an accountant and a payroll company, then I wouldn't be able to handle the corporate status. 

Money Stoic

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So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.
There is a lot more paperwork with any type of corp than with an LLC or sole proprietorship.  I am pretty detail oriented and didn't think I'd mind the extra paperwork when I signed up as an S-Corp.  6 years later, and I wish I had simplified things. 
It's not a huge deal, but when I moved into another state/got an out-of-state contract, the other state requires S-corporations to pay income tax (yeah, I didn't know that was a thing when I signed up as an S-Corp).  So I pay a small amount of corporate tax to DC and then credit the tax paid on my personal return...it's a pain.  Personally, if I weren't willing to pay an accountant and a payroll company, then I wouldn't be able to handle the corporate status.

With the S-corp, one would really be locking themselves into getting a CPA to handle it.  That is what I am debating right now.  Do you know what states charge taxes to s-corps that do business in that state?

notmyhand

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...and if the LLC had an S-Corp election, the Solo 401k would be funded with business side dollars and not subject to FICA etc...correct?  I.E...those funds would not be part of what you paid yourself, correct?

So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.

The employee portion of 17.5k is still subject to FICA taxes.  The employer portion would not be subject to FICA but will be limited to 25% of your W-2 salary, not 20% of profit minus half the self employment taxes.

So if you had an LLC taxed as an s-corp, and let's say you paid yourself 25k in salary on 30k of profits, then you could do 17.5k as the employee portion and then 25% of 25k for the employer portion.  Please note if you have not elected to be taxed as an s-corp and have not run payroll throughout the year, there is not a good way to fix it at year end.

If you have an LLC taxed as a sole proprietor, you can do 20% of 30k minus whatever half the self employment taxes end up being (~$2200) as the employer portion and then 17.5k as the employee portion.

Edited-> the s-corp example doesn't quite add up as both sides add up to over 30k but the idea works.  Play with the numbers to make it work.
« Last Edit: December 22, 2014, 06:43:08 PM by notmyhand »

notmyhand

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So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.
There is a lot more paperwork with any type of corp than with an LLC or sole proprietorship.  I am pretty detail oriented and didn't think I'd mind the extra paperwork when I signed up as an S-Corp.  6 years later, and I wish I had simplified things. 
It's not a huge deal, but when I moved into another state/got an out-of-state contract, the other state requires S-corporations to pay income tax (yeah, I didn't know that was a thing when I signed up as an S-Corp).  So I pay a small amount of corporate tax to DC and then credit the tax paid on my personal return...it's a pain.  Personally, if I weren't willing to pay an accountant and a payroll company, then I wouldn't be able to handle the corporate status.

With the S-corp, one would really be locking themselves into getting a CPA to handle it.  That is what I am debating right now.  Do you know what states charge taxes to s-corps that do business in that state?

Depends, some states don't charge anything different than what an LLC taxed as a sole proprietor would pay and some states tax extra.

Money Stoic

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...and if the LLC had an S-Corp election, the Solo 401k would be funded with business side dollars and not subject to FICA etc...correct?  I.E...those funds would not be part of what you paid yourself, correct?

So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.

The employee portion of 17.5k is still subject to FICA taxes.  The employer portion would not be subject to FICA but will be limited to 25% of your W-2 salary, not 20% of profit minus half the self employment taxes.

So if you had an LLC taxed as an s-corp, and let's say you paid yourself 25k in salary on 30k of profits, then you could do 17.5k as the employee portion and then 25% of 25k for the employer portion.  Please note if you have not elected to be taxed as an s-corp and have not run payroll throughout the year, there is not a good way to fix it at year end.

If you have an LLC taxed as a sole proprietor, you can do 20% of 30k minus whatever half the self employment taxes end up being (~$2200) as the employer portion and then 17.5k as the employee portion.

Interesting...so for W-2 Employees, is what they put into a 401k through an employer plan still have FICA withheld?  For some reason, I thought it was pre-employment tax from my days as a W-2 employee. 

Does anyone else agree that the U.S. tax code is absurd and needs to be blown up?

notmyhand

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...and if the LLC had an S-Corp election, the Solo 401k would be funded with business side dollars and not subject to FICA etc...correct?  I.E...those funds would not be part of what you paid yourself, correct?

So, is the only reason not to elect S-corp the extra cost of submitting a corporate tax return with a CPA?

It sounds that if you are going to be maxing a Solo 401K, you should go S-corp.

The employee portion of 17.5k is still subject to FICA taxes.  The employer portion would not be subject to FICA but will be limited to 25% of your W-2 salary, not 20% of profit minus half the self employment taxes.

So if you had an LLC taxed as an s-corp, and let's say you paid yourself 25k in salary on 30k of profits, then you could do 17.5k as the employee portion and then 25% of 25k for the employer portion.  Please note if you have not elected to be taxed as an s-corp and have not run payroll throughout the year, there is not a good way to fix it at year end.

If you have an LLC taxed as a sole proprietor, you can do 20% of 30k minus whatever half the self employment taxes end up being (~$2200) as the employer portion and then 17.5k as the employee portion.

Interesting...so for W-2 Employees, is what they put into a 401k through an employer plan still have FICA withheld?  For some reason, I thought it was pre-employment tax from my days as a W-2 employee. 

Does anyone else agree that the U.S. tax code is absurd and needs to be blown up?

Yes, 401k contributions as a W2 employee are still subject to FICA taxes.  Look at an old W2, Box 1 will be reduced by your 401k contributions but boxes 3 and 5 will not be.