Tips for Self-Employed Retirement Planning

Tips-for-Self-Employed-Retirement-Planning

Do you own a successful small business with no employees and want to set up a retirement plan? Or do you want to upgrade from a SIMPLE IRA or Simplified Employee Pension (SEP) plan? Consider a solo 401(k) if you have healthy income and want to contribute substantial amounts to a retirement nest egg. Keep reading to learn tips for self-employed retirement planning.

This strategy is geared toward self-employed individuals including sole proprietors, owners of single-member limited liability companies, and other one-person businesses.

Go It Alone

With a solo 401(k) plan, you can potentially make large annual deductible contributions to a retirement account.

For 2022, you can make an “elective-deferral contribution” of up to $20,500 of your net self-employment (SE) income to a solo 401(k). The elective-deferral contribution limit increases to $27,000 if you’ll be 50 or older as of December 31, 2022. The larger $27,000 figure includes an extra $6,500 catch-up contribution that’s allowed for these older owners.

On top of your elective-deferral contribution, an additional contribution of up to 20 percent of your net SE income is permitted for solo 401(k)s. This is called an “employer contribution,” though there’s technically no employer when you’re self-employed. (The amount for employees is 25 percent.) For purposes of calculating the employer contribution, your net SE income isn’t reduced by your elective deferral contribution.

For the 2022 tax year, the combined elective deferral and employer contributions can’t exceed:

  • $61,000 ($67,500 if you’ll be 50 or older as of December 31, 2022), or
  • 100 percent of your net SE income.

Net SE income equals the net profit shown on Form 1040 Schedule C, E or F for the business minus the deduction for 50 percent of self-employment tax attributable to the business.

Pros and Cons

Besides the ability to make large deductible contributions, another solo 401(k) advantage is that contributions are discretionary. If cash is tight, you can contribute a small amount or nothing.

In addition, you can borrow from your solo 401(k) account, assuming the plan document permits it. The maximum loan amount is 50 percent of the account balance or $50,000, whichever is less. Some other plan options, including SEPs, don’t allow loans.

The biggest downside to solo 401(k)s is their administrative complexity. Significant upfront paperwork and some ongoing administrative efforts are required, including adopting a written plan document and arranging how and when elective deferral contributions will be collected and paid into the owner’s account. Also, once your account balance exceeds $250,000, you must file Form 5500-EZ with the IRS annually.

If your business has one or more employees, you can’t have a solo 401(k). Instead, you must have a multi-participant 401(k) with all the resulting complications. The tax rules may require you to make contributions for those employees. However, there’s an important loophole: You can exclude employees who are under 21 and employees who haven’t worked at least 1,000 hours during any 12-month period from 401(k) plan coverage.

Bottom Line

For a one-person business, a solo 401(k) can be a smart retirement plan choice if:

  • You want to make large annual deductible contributions and have the money,
  • You have substantial net SE income, and
  • You’re 50 or older and can take advantage of the extra catch-up contribution.

Be sure to do your research for self-employed retirement planning. Before you establish a solo 401(k), weigh the pros and cons of other retirement plans — especially if you’re 50 or older. Solo 401(k)s aren’t simple but they can allow you to make substantial and deductible contributions to a retirement nest egg. The experienced team at Ramsay & Associates can help. Contact us before signing up to determine what’s best for your situation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Tax Breaks Provide Small Business Support

Tax-Breaks-Provide-Small-Business-Support

Sometimes, bigger isn’t better. Your small- or medium-sized business may qualify for smaller enterprise benefits. Some tax breaks provide small business support that isn’t available to larger businesses. Keep reading to discover some examples and find out how they may work for you.

The QBI Tax Break

For 2018 through 2025, the qualified business income (QBI) deduction is available to eligible individuals, trusts, and estates. But it’s not available to C corporations or their shareholders.

The QBI deduction can be up to 20 percent of:

  • QBI earned from a sole proprietorship or single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
  • QBI passed through from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes, or S corporation.

Pass-through business entities report tax items to their owners, who then take them into account on their owner-level returns. The QBI deduction rules are complicated, and the deduction can be phased out at higher income levels.

Eligibility for Cash-Method Accounting

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Under the cash method, you generally don’t have to recognize taxable income until you’re paid in cash. And you can generally write off deductible expenses when you pay them in cash or with a credit card.

Only “small” businesses are potentially eligible for the cash method. For this purpose, under current law, a small business includes one that has no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2022, the limit is $27 million.

Write Off Qualified Assets

The Sec. 179 first-year depreciation deduction potentially allows you to write off some (or all) of your qualified asset additions in the first year they’re placed in service. It’s available for both new and used property.

For qualified property placed in service in tax years 2018 and beyond, the deduction rules are much more favorable than under prior law. Enhancements include:

Higher deduction. The Sec. 179 deduction has been permanently increased to $1 million with annual inflation adjustments. For qualified assets placed in service in 2022, the maximum is $1.08 million.

Liberalized phase-out. The threshold above which the maximum Sec. 179 deduction begins to be phased out is $2.5 million with annual inflation adjustments. For qualified assets placed in service in 2022, the phase-out begins at $2.7 million.

The phase-out rule kicks in only if your additions of assets eligible for the deduction for the year exceed the threshold for that year. If they exceed the threshold, your maximum deduction is reduced dollar for dollar by the excess. Sec. 179 deductions are also subject to other limitations.

Bonus Depreciation

While Sec. 179 deductions may be limited, those limitations don’t apply to first-year bonus depreciation deductions. For qualified assets placed in service in 2022, 100 percent first-year bonus depreciation is available. After this year, the first-year bonus depreciation percentages are scheduled to start going down to 80 percent for qualified assets placed in service in 2023. They will continue to be reduced until they reach 0 percent for 2028 and later years.

Contact Our Tax Professionals

As you can see, tax breaks provide small business support for smaller enterprises. The business tax professionals at Ramsay & Associates can help determine if you’re taking advantage of all available tax breaks for small and large businesses alike. Contact us today if you have questions or to find out more.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.