SEP-IRA contributions

[Peter Gibbons]

Hi, 

I am 48 yrs old self-employed with a sole proprietor LLC (married filing jointly + 3 kids).  I am debating if I should max out my SEP-IRA contributions this year or not. 

Looks like I am going to fall off the ACA subsidy cliff even if I make the maximum contribution.  Net business income prior to employer SEP-IRA contribution is going to be ~ $150k plus wife's part time W-2 income of about $12k.  My reason to not contribute is because most of our nest egg is in IRA accounts and I want to avoid 10% early withdrawal penalties in the future (I plan to use SEPP withdrawals when my side hustle income drops off, but may need to supplement that if my after tax savings is consumed).

Question:  If I make employer contributions to my SEP-IRA up to 20% of my net business income, I get to avoid self-employment tax on that money, correct ?

If I understand correctly, I could make employer SEP-IRA contributions in 2019 and if I needed to, I could withdraw those contributions in 2020 with a 10% early withdrawal penalty.  But I would still come out ahead by avoiding 2019 social security and medicare taxes on those contributions, correct ?

Thanks in advance for any advice!

[terran]

No, you pay self employment tax whether or not you contribute to a self employed retirement plan. You only defer income tax. Worse still, contributions to a self employed retirement plan reduce your 199a Qualified Business Income deduction, so you effectively only get 80% of the retirement plan contribution that you normally would.

If you haven't yet contributed to the SEP for 2019 you might consider opening a solo 401(k), closing the SEP, and contributing to the 401(k) instead. The contribution limit will be higher at your income level (you have to earn near $300k from self employment before you can contribute as much to a SEP). I'm assuming you don't have another workplace retirement plan. It still won't get you out of self employment taxes and will reduce you QBI deduction, but if you'll be in a lower marginal tax bracket in retirement and/or it gets you below an ACA cliff it might still be worthwhile.

Proceed with caution if you have contributed to the SEP already this year. The plans at most providers can't coexist with a solo 401(k). Schwab's plan is the one I've seen mentioned that can.

[Peter Gibbons]

Thanks, Terran,
Unfortunately I already made some employer contribution to the SEP IRA for 2019.
I won't contribute any further for 2019.

[Phenix]

For what it's worth, Fidelity's calculator (https://scs.fidelity.com/products/mobile/sepMobile.shtml) says you could contribute a max of $27,950 with $150k of income.
And SEP contributions do reduce the employer portion of self employment taxes.  So 7.65% multiplied by $27,950 would save you over $2,100 in taxes.  Tax accountants, correct me if I'm wrong.

[terran]

For what it's worth, Fidelity's calculator (https://scs.fidelity.com/products/mobile/sepMobile.shtml) says you could contribute a max of $27,950 with $150k of income.
And SEP contributions do reduce the employer portion of self employment taxes.  So 7.65% multiplied by $27,950 would save you over $2,100 in taxes.  Tax accountants, correct me if I'm wrong.

I really don't think (like 90% sure) SEP contributions reduce self employment tax for sole proprietors. Solo 401(k) contributions definitely don't. Maybe they do if your business is taxed as as an S-Corp?

[dandarc]

For what it's worth, Fidelity's calculator (https://scs.fidelity.com/products/mobile/sepMobile.shtml) says you could contribute a max of $27,950 with $150k of income.
And SEP contributions do reduce the employer portion of self employment taxes.  So 7.65% multiplied by $27,950 would save you over $2,100 in taxes.  Tax accountants, correct me if I'm wrong.

I really don't think (like 90% sure) SEP contributions reduce self employment tax for sole proprietors. Solo 401(k) contributions definitely don't. Maybe they do if your business is taxed as as an S-Corp?

Even then it is the division of profit from Wages that reduces the self-employment tax. Presumably that "reasonably wage" you're paying yourself is the same regardless of your SEP or Solo 401K contributions.

[Peter Gibbons]

For what it's worth, Fidelity's calculator (https://scs.fidelity.com/products/mobile/sepMobile.shtml) says you could contribute a max of $27,950 with $150k of income.
And SEP contributions do reduce the employer portion of self employment taxes.  So 7.65% multiplied by $27,950 would save you over $2,100 in taxes.  Tax accountants, correct me if I'm wrong.

This is what I was thinking in the beginning.   Since I am a sole proprietor LLC, I don't really "pay myself a wage", and instead my income is considered my business income net of business expenses.  Essentially, I thought that employer contributions to SEP-IRA were accounted for like business expenses so that my business profit (my income) is reduced by the amount of the employer contribution and would allow me to not pay self employment taxes on that employer contribution amount.  Is that correct ?

[terran]

For what it's worth, Fidelity's calculator (https://scs.fidelity.com/products/mobile/sepMobile.shtml) says you could contribute a max of $27,950 with $150k of income.
And SEP contributions do reduce the employer portion of self employment taxes.  So 7.65% multiplied by $27,950 would save you over $2,100 in taxes.  Tax accountants, correct me if I'm wrong.

This is what I was thinking in the beginning.   Since I am a sole proprietor LLC, I don't really "pay myself a wage", and instead my income is considered my business income net of business expenses.  Essentially, I thought that employer contributions to SEP-IRA were accounted for like business expenses so that my business profit (my income) is reduced by the amount of the employer contribution and would allow me to not pay self employment taxes on that employer contribution amount.  Is that correct ?

I really don't think so. Take a look at schedule SE, which takes net profit from schedule C. The SEP deduction happens on schedule 1, which ends up on neither Schedule C nor Schedule SE. For an S-corp schedule SE calculates self employment taxes starting with values from schedule k-1, so you'd have to look there for that, but I suspect as @dandarc says you'll find that the lack of self employment tax on SEP contributions from an S-corp is because S-corp SEP contributions come from business profit on which you don't pay self employment taxes whether you contribute them to a SEP or not. That is, I think it's not the act of contributing to the SEP that avoids self employment tax, but rather classifying that income as profit instead of wages.

[dandarc]

I'm with terran on this one.

A good lesson here - even if you don't fill out your returns yourself, it is good to review the various forms from time to time. Particularly when you're doing stuff like managing your own retirement plans. If you know roughly how the forms all work together, it can help your tax planning.