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Tax Benefits of Implementing a Retirement Plan or Upgrading Your Current Plan

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What can I do to get more deductions and lower my tax bill? This is the question I heard again and again from my small business owner clients during this past tax season. Small business owners and self-employed individuals tend to feel the tax burden more than traditional W-2 employees. This may be because W-2 employees are paying their taxes more frequently through automatic withholdings from their paychecks, and small business owners write that dreaded check for estimated payments on a quarterly basis, if they are diligent, or pay the whole amount in a lump sum come tax time in April. Self-employed individuals also act as both employee and employer in terms of their social security and Medicare payments, meaning 15.3% in employment taxes in addition to federal and state income taxes on their net business income – ouch!

A no-brainer tax planning recommendation for a profitable self-employed or small business client is to set up a retirement plan. Retirement contributions not only save on taxes currently, but also encourage saving for the future when retirement planning may not be a small business owner’s top priority. It’s also a nice perk for retaining employees, especially during this time of low unemployment.

The following is a summary of the most popular types of IRS-approved retirement plans for small business owners, ranging from simple to more complex:

Simplified Employee Pension (SEP Plan)

  • Employer contributions on behalf of each employee cannot exceed the lesser of $56,000 for 2019 ($61,000 over 50 years old) or 25% of your net earnings/employee W-2 earnings.
  • All eligible employees must be included in the plan, and the employer makes and is entitled to a tax deduction related to all contributions.
  • The due date for contributions and set up is the due date of the tax return including extensions, which means the latest possible contribution is October 15 of the year following the reporting year.

Savings Incentive Match Plan for Employees (SIMPLE Plan)

  • Employee elective contribution maximum is $13,000 for 2019 ($16,000 over 50 years old).
  • The employer makes a deductible matching contribution of up to 3% of the employee’s compensation, or non-elective contributions of 2% of the employee’s compensation, for each employee, regardless of any salary deferrals.
  • The plan must be set up between January 1 and October 1 of the tax year.
  • Solo 401(k)/Individual 401(k)

    • Self-employed individuals with no employees can make income deferrals up to $19,000 for 2019 ($24,000 over 50 years old) plus contribute up to an additional 25% of net earnings, for a maximum total contribution of $56,000 ($61,000 over 50 years old).
    • Roth designated contributions are available.
    • The plan must be set up by the end of the tax year, and contributions must be made by the due date of the tax return including extensions.
    • The taxpayer may need to file a form 5500, Annual Report of Employee Benefit Plan, if plan assets are greater than 250,000.

    401(k)

    • The employee elective contribution maximum is $19,000 for 2019 ($24,000 over 50 years old).
    • Roth designated contributions are available.
    • Employers can make discretionary matching contributions and/or profit sharing contributions.
    • Employee and employer total contributions cannot exceed the lesser of 100% of the employee’s compensation or $56,000 ($61,000 over 50 years old) per employee.
    • Deductions for contributions are limited to 25% of total employee compensation.
    • The plan must be set up by the end of the tax year, and contributions must be made by the due date of the tax return including extensions.
    • Form 5500, Annual Report of Employee Benefit Plan, is required.
    • Defined Benefit Plans

      • Not as popular as they once were due to the financial burden and risk on employers, a defined benefit plan may make sense for a small business with a single owner/employee.
      • The contribution limit is the lesser of $220,000 for 2019 or 100% of the participant’s average compensation for the highest-compensated three consecutive calendar years.
      • Contributions are based on what is needed to provide determinable benefits to the participant.
      • Deductions for contributions must be determined by an actuary.
      • The taxpayer may need to file a form 5500,Annual Report of Employee Benefit Plan, if plan assets for a single participant are greater than 250,000. Form 5500 is required if the plan has more than one participant.

      A retirement plan is a valuable tool to maximize tax deductions while also providing the benefit of future retirement savings to small business owners and their employees. There is much to consider in selecting the most advantageous retirement plan and strict rules to follow to ensure the plan is set up properly. Ask Marcum which retirement plan would best suit your small business.

 
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