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Taxes and the Solo 401k: What to Tell Your CPA

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Is your CPA up to snuff on your Solo 401k? What is your business situation? Are you a W-2 employee for an employer but also running your own business as a sideline? Real estate investing has long been one of the most popular and profitable side businesses. Of course, there are many other businesses you can easily operate part time. A Solo 401k is available to anyone with a part time or full time business.

Choosing a CPA

Maybe you’re already in the business and need to talk with a CPA about reducing taxes or increasing income. Or maybe you’re just ready for some professional accounting help with the funds currently in your retirement account. Tax and retirement fund discussions should involve the topic of opening a Solo 401k including the advantages provided beyond a SEP IRA (better 401k contribution limits), beyond a corporate 401k (better Solo 401k tax sheltering), or a SDIRA (for freedom of investments).

Whether you have a CPA or are looking for one before the tax year ends, you need to be aware that not all CPAs are well-versed in the Solo 401k. Providing a list of CPAs knowledgeable about alternative retirement accounts and the Solo 401k in particular is a service that we provide here at Solo But we also realize you may want to work with a CPA already familiar with your business. Still, your accountant should have a foundation in what the IRS calls One-Participant 401(k) Plans. CPAs who understand this will discuss how the Solo 401k exceeds the advantages of all other retirement account structures.

Solo 401k Contribution Advantages Over a SEP IRA

An outdated argument for a SEP IRA is that these are easier and less expensive to setup. But that is old school thinking. Not only is the cost competitive here at Solo but more importantly, any difference in cost is significantly offset by your ability to contribute more money before taxes. Regarding ease of setup – your Solo 401k plan and trust documents are generated in 1 business day or less.

The contribution advantage begins with the fact that by being self-employed enables you as both the business owner and as an employee to make two distinct tax reducing contributions to the Solo 401k.

At first glance, both the Solo 401k and the SEP IRA seem to have the same contribution limit of $56,000 for tax year 2019. But that isn’t accurate for many people because the Solo 401k has the “catchup provision” for people over age 50. The catchup provision increases the limit to $62,000. There is no catchup provision with the SEP IRA.

With a SEP IRA, your contribution is limited to 25% of your salary, or 20% of earned income. The employer portion of the Solo 401k contribution is the same (25% of your salary, or 20% of earned income). However, the Solo 401k allows you (as an employee) to make a separate contribution of $19,000 in 2019 ($25,000 over 50 catchup limit. That makes a significant difference between the two account types. With a SEP IRA, you have to pay yourself a much higher salary to obtain the full $56,000 tax deferred deduction. Of course, you’ll pay more in personal taxes on that higher salary when you can’t tax defer the additional $19,000, which is only available with the Solo 401k.

Better Tax Shelters

Truth be told, the employer limits on your corporate 401k are the same for a Solo 401k because both follow essentially the same IRS tax deferred income rules. You can defer up to 100% of your income and the employer can contribute up to 25% of your salary. But that 25% is what makes a big difference between a corporate 401k and a Solo 401k. Do any corporate 401ks actually contribute anywhere near the full 25%?

The national average corporate match is only 4.7% of an employee’s full salary. Right there you can increase your tax deferral another 20.3% using the full 25% allowed with a Solo 401k.

Neither do corporate employers match the entire 100% of your salary if you were to contribute it all to your 401k. At best, you can only expect corporate employers to match about 6% of your salary. And it often goes down from there. Most people only contribute the percentage of their income that the employer matches. With a Solo 401k, you can tax defer 100% of your salary and then match that with another 25% as the employer. The available Solo 401k tax deferred contributions are much higher than the amount corporations actually contribute.

The other big tax shelter comes from your ability to include a spouse in a Solo 401k. He or she will have the same contribution limits and the same employer contributions. Altogether, a Solo 401k shelters considerably more income than even the best employer 401k plan.

More Investment Freedom

In many ways, a Solo 401k offers more financial freedom compared to a self directed IRA (SDIRA). To begin with, 401k’s don’t require the added layer of bureaucracy of an IRA custodian. Custodians have to approve your investments before your money is made available. Although alternative investments can be made with an SDIRA, many custodians have become leery about approving any investments they don’t fully understand.

Among the other investment and financial freedoms enjoyed by Solo 401ks are:

Any discussion with a CPA knowledgeable about the Solo 401k will conclude that the benefits of a Solo 401k are far superior to other self directed retirement accounts and even employer sponsored 401ks. At the least, a Solo 401k is a strong compliment account alongside an employer 401k.

Have questions about growing your retirement account? The 401k experts at Nabers Group will help you get your retirement funds into your control, where they belong. Contact us here.

2 Responses

  1. Hi, I have a ROBS funded C-corp that was setup in 2017. I’m looking for an advisor to assist me with ongoing compliance & tax support. I don’t think the advisor I currently use has filed a form 55000 in some time. I need help filing those forms. Thank you.

  2. Hey guys – reaching out here since the retirement desk wasnt too helpful. I’m filling out a form for a new payroll provider. Single person New Jersey LLC taxed as S-corp setup here (filing quarterly 941s, and just one w-2 for myself as employee). They ask which taxes is the Fidelity 401(k) plan exempt from. Can someone please advise:
    1. Federal Income Tax (FIT) – Exempt?
    2. State Income Tax (SIT) – Exempt?
    3. FICA – Not Exempt?
    4. Medicare – Not Exempt?
    5. Local Taxes – Exempt?
    6. Federal Unemployment (FUTA/FUI) – Not Exempt?
    7. State Unemployment Tax (SUTA) – Not Exempt?
    8. Federal Income Tax (FIT) – Exempt?
    9. State Income Tax (SIT) – Exempt?
    10. FICA – Exempt?
    11. Medicare – Exempt?
    12. Local Taxes – Exempt?
    13. Federal Unemployment (FUTA/FUI) – Exempt?
    14. State Unemployment Tax (SUTA) – Exempt?

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