Tax Tips Blog

Mark writes: I have a side business with no employees. My understanding of the solo 401k is that you can contribute 15k initially and then 25% of your income. My side business nets 12k-15k. Would I be able to, after paying self employment taxes, contribute the remaining amount in into the solo 401k. Also, I contribute to a 401k through my other job as well. Would I be able to max it out as well?

Thanks for your help,
Mark

My reply: Hi, Mark thanks for visiting! Employee elective deferrals to a solo 401(K) plan are limited to $15,500 for 2008. This means that all of your employee elective deferral contributions for your 401k from all of your employers including your solo 401k from your sideline C business are limited to $15, 500.

However, there are two contribution parts with a solo 401(k). First, you can contribute up to 100% of the first $15,500 of your 2008 compensation or self-employment income ($20,500 if you’ll be 50 or older at year-end). Second, you can contribute and deduct an additional amount of up to 25% of your compensation income, or 20% of your self-employment income.

Because of these two parts you could make employee elective contributions of $15,500 to your 401k at your regular job (assuming your compensation is high enough) and then contribute based on the profits of your sideline business.

But I think you should look into the SEP for your sideline business because you can accomplish the same thing with less paperwork.

Best wishes,

Gina

Rich asks:I’m thinking about opening a SEP-IRA this year. I believe the contribution limit is 25% of profits up to $44,000. If I have two different sole proprietorships, would I have to open two different SEP-IRAs or could I contribute 25% of total profits to just one IRA? TIA.

My reply: First if you already have a traditional IRA account you do not need to open any new accounts, but some custodians may make you open a new one anyway.

Second, because of the adjustment for 1/2 of your self-employment tax, your maximum contribution usually works out to 20% of the sum of your net taxable profit reported on your Schedules Cs up to $45,000 this year.

You may want to read IRS Publication 560.

Best wishes,

Gina

Karen writes:I know this is an easy stupid question and I need an answer really fast. I’m trying to do my 2006 taxes. I’m filing joint. I have maxed out my 401K and will not be making any additional IRA contributions. I’m not yet 50. I had a business for a part of the year this year. My income from my job for part of the year barely makes it above the $76,000 mark for Social Security, so I shouldn’t have to pay any self-employment SS taxes. However, I know that Medicare is not capped. Can you please tell me what the tax rate is for Medicare (I can’t seem to locate it,) so I can figure my SEP-IRA contribution correctly? Thanks.

My reply: I hate to be the bearer of bad news, but the social security tax limit goes up every year and in 2006 that limit was $94,600, not the $76,000 you thought it was (that was correct in 2000). You can find these limits and the rates on the Social Security Adminstration’s website. This means you will probably have to pay self-employment taxes. The rates for 2006 are as follows:

• SS (OASDI) employee 6.20% (capped at $94,600)
• SS (OASDI) employer 6.20% (capped at $94,600)
• Medicare employee 1.45% (no limit)
• Medicare employer 1.45% (no limit)

So if you made exactly $76,000 from your part time job, you’ll be paying 7.65% in Social Security and Medicare taxes on those wages. Then you’ll be paying 15.3% on $up to 18,400 from your self-employment income and paying 2.9% on your self employment earnings above $18,400, if any. You are entitled to an adjustment for one-half of the self-employment taxes that you will be paying.

401(k) and IRA deductions do not affect Social Security or Medicare taxes - only income taxes, so if your part year job was $76,000 after your $15,000 401(k) deduction, you won’t have to pay social security taxes on quite so much of your self-employment income, but you would still be a little under the limit at $91,000.

You’ll need to compute your self-employment tax, which is not affected by the SEP deduction, before you can figure your maximum SEP contribution. You may want to read IRS Publication 560 and then find a qualified tax professional to help you finish your return.

Best wishes,

Gina

www.GLGcpa.com

Charlie asks:I have been contributing to a Roth IRA to the max amount and a little bit to a 401k. My employer also runs a profit sharing type plan that they contribute to. Now, the question is, am I also able to contribute to an SEP-IRA? I do contract work on the side and receive 1099s. For status I am single and my W2 income will be in the 60-70k range and my self employment will be about $10k. Am I able to also do an SEP with the profits from the self-employment (assume this would be after business-expense deductions relating to the SE). What tax advantages would that offer me over a taxable brokerage acct? Thanks, Charlie

My Reply: Hello Charlie, thanks for writing.

Yes you should be able to contribute to a SEP due to the profits from your self-employment income. You can learn more by reading IRS Publication 560.

As far as tax advantages are concerned, you will get a current deduction for the entire contribution and tax on the earnings is deferred until your withdraw the money in retirement.

Best wishes, Gina www.GLGcpa.com