We’re heading into the end of 2022, and it’s around this time of year when tax projections of business profits are performed. It’s also when business owners and their accountants begin mapping out year-end strategies to minimize their taxes to get their company’s business income right where it needs to be.
So this year, talk to your accountant and make sure you don’t overlook one of the most commonly used deductions a business can make to minimize taxes—those which allow for retirement plan contributions.
“Many businesses still use a Traditional IRA plan, which may have been the right plan to use years ago, but it may not be the most effective retirement plan strategy for where your business is today,” says Daniel Portillo, Rock & Hammer’s senior accountant. “Using the right retirement plan will allow for the largest pre-tax contributions, resulting in a lower overall tax bill.”
The Solo 401K plan offers some of the most generous contribution limits of any retirement account. It allows for contribution limits of up to $61,000 for 2022 ($67,500 if you’re age 50+) whereas the IRA allows contribution limits of up to $61,000 for 2022 ($7,000 if you’re age 50+). The SEP IRA is capped at $61,000, and no catch-up contributions—nor employee contributions—are allowed.
For small business owners, what’s the best way to go? Both SEP IRA’s and 401k’s can be a good strategy, but which would make a better one will depend on where you’re at as a business. Both are easy to set up and operate with low administrative costs, so let’s consider the differences.
Solo 401k’s. Depending on the amount of business income required to max out an annual contribution, a Solo 401k typically provides much greater tax efficiency with contribution amounts than would the SEP IRA. Also, options such as Roth and the 401k loan are available with a Solo 401k— but not the SEP IRA.
Each year, as the tax deadline approaches, the self-employed business owner who has a Solo 401k plan has a powerful tool to lower last year’s taxes and put away a meaningful amount for retirement.
If your business is structured as a corporation, you can put employer contributions of up to 25% of W-2 earnings into the 401k plan. “If you’re a sole proprietor or own an LLC (or partnership), this percentage would change to 20% of your net Schedule C,” Portillo says. “Just keep in mind that the total contributions as an employer and employee cannot exceed a combined total of $61,000 for the 2022 tax year, or $67,500 if you’re over the age of 50 and you’ve maxed your employee ‘catch-up’ contribution.”
Thinking about making a move to the 401k plan? Schedule a consultation with us. Each November and December, we help businesses set-up a 401k—or any other plan— that is best for it, and for you.
Leave a Reply