Tax Planning Series: Reduce Your Business Taxes with Retirement Plan Contributions
Now that your business is at the end of its year, let’s look at an effective tax planning method of making retirement contributions. We will compare the features of a SEP (Self Employed) IRA, Simple IRA, and Solo 401(K) Plan.
SEP IRA
A SEP IRA can be set up by anyone with self-employment income. The SEP IRA is funded 100% by the employer, each employee has their own separate account that is 100% vested after each employer contribution is made.
What are the contribution limits for employer and employee accounts?
The employer’s maximum contribution into their own account is a complicated calculation but comes to 18.6% of net income. He may contribute less but must contribute to the employee’s account in the same ratio as his own. Example: Owner contributes 10% of net income into his own SEP account, he must now contribute 10% of each eligible employee’s W-2 wages into that employees individual SEP account. The employee cannot contribute themselves.
Who is considered an eligible employee?
An employee at least 21 years of age and has worked at the company for 3 out of the last 5 years and makes at least $600 in the current year.
When must the plan be established and contributions made?
The plan must be established and contributions made by the due date of the tax return including extensions for the year the plan is to be effective. Example: The 2017 tax return for an extended S Corp is September 15, 2018. The plan must be established and funded by September 15, 2018 for the year 2017.
What are the administration requirements for the employer?
Easy to administer, no annual tax return or report is necessary
Contributions are not mandatory each year by the employer. The employer gets a tax deduction for all employer contributions made in the year and the employee pays no taxes on the amounts the employer made into their individual accounts until the funds are withdrawn by the employee after the employee reaches 59.5 years of age.
Simple IRA
A Simple IRA can be sent up by any employer with less than 100 employees. Both employer and employee are allowed to make contributions into this plan. Each employee has their own separate account that is 100% vested after each contribution is made.
What are the contribution limits for employer and employee accounts?
Employees can contribute up to $12,500 with an additional $3,000 if 50 years of age or older. The employer either matches the employee’s contribution up to 3% of the employee’s wages or contributes up to 2% of the employee’s wages.
Who is considered an eligible employee?
Employees that have earned at least $5,000 from the employer in any prior 2 years.
When must the plan be established and contributions made?
The plan must be established by October 1, 2017 for new plans first in effect by 2017. Employee contributions must be deposited within 30 days of receiving their paycheck and employer contributions have until the due date of the tax return including extensions.
What are the administration requirements for the employer?
Easy to administer because there are no requirements for complex nondiscrimination testing and no annual tax returns are necessary.
Contributions are not mandatory for employees but are mandatory each year by the employer. The employer gets a tax deduction for all employer contributions. The employee contributions are pre-taxed which means the employee’s contributions lower the employee’s taxable wages. The employee pays no tax on the employer and employee contributions until the employee withdraws funds after reaching 59.5 years of age or older.
Solo 401(k)
Designed for an individual owner, it is technically available to the spouse of the owner and any shareholder or partner in the business as well. If you hire even a part-time employee that works over 1,000 hours per year, you will have to move to one of the previous plans. Contributions are 100% vested at the time of the contribution.
What are the contribution limits for employer?
Business owners can contribute up to $18,000 per year or $24,000 if age 50 or older. On top of the $18,000, the owner can contribute an additional contribution of 25% of their W-2 wages. Total contributions (not including the $6,000 contribution for being 50 or older) cannot exceed $54,000.
Who is considered an eligible participant?
Only owners and spouses.
When must the plan be established and contributions made?
The plan must be established by the end of the tax year in order to make a contribution that year. Example: For the year 2018, the plan needs to be in place on December 31, 2018
What are the administration requirements for the employer?
Easy to administer because there are no requirements for complex nondiscrimination testing and no annual tax returns are necessary.
There is both an non-elective plan in which you will have to make a contribution each year and a elective plan in which a contribution each year is not mandatory. The business owner gets a business deduction for the employer portion of the contribution ($18,000 max) and the employer’s taxable W-2 is reduced by the paycheck portion of the contribution (25% max). The amounts are not taxed until the owner withdraws the funds at age 59.5 or older.
For a business owner without employees that has significant income, the Solo 401(k) maybe a very good choice since it allows the greatest amount of income deferral. For a business owner that wants to offer employees an incentive to remain with the company long-term and still enjoy a business deduction for their contributions to the employee’s account, either the SEP or Simple IRA would be a good choice.
Another good choice is to consider H&S Accounting CPAs LLC for your tax planning and Income Tax Returns needs.
Tim Walch CPA