Author Topic: CSS 2020 effects of employer tax deferred plans vs tIRA vs Self-employed plans  (Read 612 times)

johnhenry

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I'm using the CSS 2020 spreadsheet to explore scenarios for a family with 3 kids, MFJ to have wages or self-employment that targets the threshold at which income is most tax efficient. If I'm interpreting the CSS correctly, a family could have around $25K in wages where everything below that has a negative marginal rate.  The family could have around $15k in net Sch C income with a negative marginal rate (with income above $15k, up to about $26K) at only a .20% marginal rate.

Using those thresholds as baselines incomes to "target", I also wanted to explore strategies for reducing tax in the event where the target income was "overshot".  For example, the family wants to target $24K in wages, but makes $36k.  Or targets $24k in SE income, but makes $36k. 

Using those examples above.... if I'm using and interpreting the CSS correctly (which may be a big IF), it seems easy enough, with $36K in wages to use an employer-based 401(k) to contribute $12K and maintain a negative marginal rate up to the $36K earned.  Before running the CSS, I assumed that contributing $12K to a tIRA would have the same effect, but it doesn't.  It does effect the marginal rate, but only for higher income than $36k.  Can anyone explain this to me in laymen's terms?

When I did the same exercise with $36K in net Sch C income, it seemed to indicate that both tIRA deductions or SE deductions of $12K would have the same effect.  That is, they effect the marginal rate, but only at incomes over $36K.  They don't seem to expand the space for income with negative marginal rates.

Is there any certain way Sch C earnings and/or SE deductions can be structured to behave like employer-based 401(k) contributions, for this purpose? We already have a Sole Propietorship and each of us has a Solo 401(k) through it, that we have used on/off for side income over the years.

Even having to overcome the extra expense of self-employment taxes, implementing a strategy like this is probably going to be easier for us with self-employment contract work instead of wages.




MDM

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I'm using the CSS 2020 spreadsheet to explore scenarios for a family with 3 kids, MFJ to have wages or self-employment that targets the threshold at which income is most tax efficient. If I'm interpreting the CSS correctly, a family could have around $25K in wages where everything below that has a negative marginal rate.  The family could have around $15k in net Sch C income with a negative marginal rate (with income above $15k, up to about $26K) at only a .20% marginal rate.
Same comments about 2020 vs. 2021 tax law, and not letting the tax tail wag the dog as in using the CSS to see the effect of both salaries combined.

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Using those examples above.... if I'm using and interpreting the CSS correctly (which may be a big IF), it seems easy enough, with $36K in wages to use an employer-based 401(k) to contribute $12K and maintain a negative marginal rate up to the $36K earned.  Before running the CSS, I assumed that contributing $12K to a tIRA would have the same effect, but it doesn't.  It does effect the marginal rate, but only for higher income than $36k.  Can anyone explain this to me in laymen's terms?
The earned income credit (EIC) calculation may test both "earned income" and "adjusted gross income," and then use the one that provides the lowest EIC.  A 401k reduces both earned income and AGI, while a tIRA reduces only AGI.

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Is there any certain way Sch C earnings and/or SE deductions can be structured to behave like employer-based 401(k) contributions, for this purpose? We already have a Sole Propietorship and each of us has a Solo 401(k) through it, that we have used on/off for side income over the years.
Don't understand - if you have a solo 401k, why not use it?

johnhenry

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The earned income credit (EIC) calculation may test both "earned income" and "adjusted gross income," and then use the one that provides the lowest EIC.  A 401k reduces both earned income and AGI, while a tIRA reduces only AGI.
Thanks! That's exactly what I was looking for!


Don't understand - if you have a solo 401k, why not use it?

If we have self employment income on our Schedule C instead of earned wages, we will use that.  Part of this analysis is how taxes would be affected by having earned wages vs. self employment income.

Do solo 401(k) contributions reduce earned income and AGI? Or just AGI?

Maybe this is the same question, but on the CSS, do all Solo 401(k) employee and employer (profit sharing) get combined into cell B47? (or C47 for the spouse).


MDM

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Do solo 401(k) contributions reduce earned income and AGI? Or just AGI?

Maybe this is the same question, but on the CSS, do all Solo 401(k) employee and employer (profit sharing) get combined into cell B47? (or C47 for the spouse).
If I read the Earned Income section of the Form 1040 Instructions, solo 401k contributions do not affect earned income but do affect AGI.  This differs from employer-sponsored 401k contributions, and yes all the solo 401k contributions, whether employee or employer, go in B47/C47.  That seems consistent with the IRS instructions.

johnhenry

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Thanks @MDM

Since a Solo 401(k) would not reduce earned income, can anyone offer advice about setting up a small plan 401(k) through Vanguard or similar?  And confirm that contributions to it by business owners would reduce earned income?  We already each have Roth, tIRA, and Solo 401(k)s through Vanguard.  We had a few years where we both had some Sch C income and made employer contributions and one of us was also able to make some employee contributions. But so far, we've never had the need to pay ourselves wages or issue W-2s.
 
I'm almost certain the small plan 401(k) would be more work and cost more... but not sure how much.  I know in most cases small businesses would do anything to avoid a full employer plan if the Simple, Solo, etc would meet their needs.... but maybe a small business plan is the only option that achieves the goal here?

A few specific questions.

1) Does anyone know how much a small plan 401(k) would cost from Vanguard for 2 employees.
2) Does Vanguard require a business structure other than a Sole Proprietorship to set one up?
3) Is it possible (and if so, desirable) to just keep the Sole Proprietor designation and still issue wages to self/spouse? 
4) Is it possible to use QB Online etc to just run payroll once per year to issue checks to 2 employees? I'm guessing that will be a requirement to generate W-2s and then remit withholding to state, federal.
5) I think* that the small plan 401(k) allows the same amount of employer based contributions at the Solo 401(k).  Is that true?

Again, this is an attempt to determine what tools would need to be in place for a retired couple with a few kids and a modest amount of self-employment income to make contributions to deferred accounts that would reduce their earned income AND AGI in order to achieve the level of income that resulted in the largest earned income tax credit (as opposed to using a Solo 401(k) which can't reduce earned income). The assumption here is that living expenses can be fully funded by drawing down taxable accounts so most/all net business income would/could be paid out in wages, and as much of those wages as necessary could be contributed to the business 401(k) plan.