As a small business owner, you take risks and work hard for your money. Naturally, you want to keep as much of it as legally possible. Fortunately, the tax code offers several tax efficient structures that help small business owners to shelter their earnings from the IRS by taking a deduction in the current tax year.
A 401k is a tax-deductible retirement plan that is typically created by employers for the benefit of their employees. A Solo 401k is similar, but is created by a business owner for her own benefit.
The contribution to a Solo 401k comes in two parts: an employee contribution of up to $18,000 in 2016 ($24,000 if over age 50) and an employer contribution of 20% of business profit (25% for S-corporations), up to $35,000 (in 2016). Altogether, a small business owner can defer taxes on up to $53,000 by contributing to her own Solo 401k. The total contribution limit increases to $59,000 if the business owner is over 50.
Setting up and maintaining a Solo 401k can be complex tasks. The 401k itself is a Qualified Retirement Trust; the business owner must get an Employer Identification Number for the Trust. Also, the business owner or plan administrator must file form 5500-EZ with the IRS for each year that the plan contains in excess of $250,000.
Simplified Employee Pension IRA (SEP IRA)
The SEP IRA is a type of Individual Retirement Account created for small business owners. The SEP IRA is different from the Solo 401k in that it includes only one type of contribution. For 2016, the IRS allows business owners to contribute up to 20% of business profit (25% for S-corporations), with an overall limit of $53,000. Money contributed to an SEP IRA can be deducted from your taxes in the current year.
Unlike a Solo 401k, an SEP-IRA does not require its own EIN. No annual filings are required.
Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA)
The SIMPLE IRA is another tax-efficient retirement plan structure available to small business owners. Like 401ks and SEP IRAs, contributions to a SIMPLE IRA are tax-deductible in the year that they are made.
Employers are required to make regular contributions to the SIMPLE IRA. Employers can either match employee contributions up to the first 3% of salary or contribute a flat 2% of salary for all employees who earn at least $5000 in a year.
The SIMPLE IRA has a lower contribution limit than the Solo 401k. For 2016, the maximum that an employee can contribute to a SIMPLE IRA is $12,500. Employees over age 50 can make an additional contribution of up to $3000.
Unlike the 401k, the SIMPLE IRA does not require creation of a trust and need not have its own Employer Identification Number.
Anyone with employment income can contribute to a tax-deductible Traditional IRA. Unfortunately, the contribution limits and income limits are rather low. For 2016, the maximum Traditional IRA contribution is $5,500 ($6,500 if age 50 or older). A taxpayer who participates in an employer-sponsored retirement plan can deduct her entire contribution if she has an Adjusted Gross Income (AGI) of $61,000 or lower; if there is no employer-sponsored plan, this limit does not apply.
Health Savings Account (HSA)
Although Congress designed the Health Savings Account (HSA) to help people pay for healthcare, it can also be used as a savings and retirement vehicle. HSA contributions are tax-deductible when made, and withdrawals are deductible if made to pay for qualified health services. For 2016, the maximum contribution that an individual can make is $3,350.
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As a small business owner, you work hard for your money. These and other tax-efficient structures can help you to save for the future while also minimizing your tax burden. For help choosing the right tax-efficient vehicles for your savings, please contact us.