In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the tax deductions you can still claim if you have self-employment income and filed an extension on your tax return.
Not Too Late to Max Out Your Solo 401(k) Contributions for 2021
Hey, everyone, Adam Bergman here, tax attorney and founder of IRA Financial. On today’s episode, if you’re self-employed or a small business with no full-time employees other than the owners or their spouses, there is still time to take advantage of generating massive deductions for 2021. So, if you have a single member LLC or a Schedule C taxpayer, so if you’re a 1099, you have a Schedule C, or you are filing a return for a sole proprietor, single member LLC, you have the ability to still, yes, if you are under extension, still have a chance to claim tax deductions for the 2021 year up until October 15. Now, if you are an 1120 taxpayer, so if you have an S corp, for example, or you’re a partnership, 1065, you have until September 15 to take advantage of the opportunity to still max out your Solo 401(k) for 2021.
So, this is probably the only chance that you can still claim some deductions for the 2021 tax year, right? Everything’s gone. It’s in 2022, right? So, you can’t have business deductions now for 2021, right? Once January 1 rolls around, you’re done. You cannot generate any business-related deductions: depreciation, entertainment expenses, food expenses, rent, so on and so forth. It’s gone, right? The year is finished. However, 401(k)s, Solo 401(k)s to be exact, are really the only retirement account, other than SEP IRAs, where you can still claim deductions in 2022 for the ’21 taxable year. For 2021, the most you can contribute to a SEP IRA or Solo 401(k) is $58,000, or, if you’re over 50, $64,500. Now, the SEP does not have a catch-up if you’re over 50.
So, before the SECURE Act, which was passed in December 2019, only a SEP IRA was able to be created in, for example, 2022 for the 2021 taxable year. SECURE Act changed that to allow Solo 401(k) to be established in 2022, so long as it’s established before the return has been filed, including extensions for the ’21 taxable year. Now, the only caveat is only profit sharing contributions can be made, not employee deferrals. In 2021, the employee deferrals, if you’re under 50 was $19,500 or $26,000 if you’re over 50. Employee deferrals are dollar for dollar, meaning if you made $30,000, you can contribute $19,500 or $26,000 if you’re over 50.
Profit sharing is a little different. It’s essentially a percentage. Profit sharing is also known as employer contributions. It’s essentially 20% of your comp if you’re a single member LLC or sole proprietor, and 25% of your W-2 if you’re a CRS. Now, don’t ask me why the percentages are different. Complex calculation, but trust me, those are the numbers. So, if you made $100,000 and you’re a sole proprietor, you can put away 20%. If you just had a pure profit sharing plan, like a SEP, that’s $20,000. Or if you had a W-2 S corp, you can do 25% – $25,000 of $100,000.
So, as of today, so long as you adopt the plan either before September 15 if you are an S Corp or you file 1065 Partnership, or October 15 if you follow 1040 Schedule C or an 1120 C Corporation, you can establish a plan, whether it’s a SEP or a Solo 401(k) plan in 2022 for the 2021 taxable year. That means you can potentially gain deductions of up to $58,000 if you’re under 50, and $64,500 if you’re over 50.
So, let’s say you made $200K and you’re listening to this podcast, you’re watching this podcast, and you haven’t set up a SEP yet, or a Solo 401(k). Let’s assume you’re self employed, you’re a consultant, you get paid on 1099, or you have a single member LLC, and you make $200K net Schedule C, you can do 20% of $200K, it’s a $40,000 deduction. Meaning instead of paying tax on $160K, on $200K excuse me, you’re paying tax on $160K, plus that $40,000 now is in a retirement plan that can grow without tax.
Now, in 2022, you can start adding employee deferrals. But for the ’21 taxable year, you’re relegated to just doing profit sharing. Not ideal, but hey, $40,000 deduction is a massive deduction that you can get in 2022 for 2021. It’s really the only available deduction that’s still left; if you’re scrambling to reduce your taxable income, if you’re an accountant, you’re listening to/watching this or you’re just interested, you may want to reach out to your tax professional. Let them know if you do not have a retirement plan set up either it’s a SEP or a Solo K, you should set one up.
I strongly suggest doing the Solo K, and I’ll explain why. I’ve written two books on the Solo 401(k). The SEP IRA is a pure profit sharing plan. It’s 20% of your Schedule C or 25% if you’re a W-2. The aggregate is $58k, or $64.5K in ’21; in ’22, it’s a higher number of $61,000, or $67,500 if you’re over 50. Now, a Solo 401(k) has the employee deferral, of that $19,500 or $26,0oo in ’21, plus that 20 or 25%. Okay?
So, if you made $100K and you had a SEP IRA, let’s say you’re an S Corp, only owner, only employee, you can do $25,000 25% of your $100K. If you had a Solo K, you can do $25K profit sharing, same as a SEP, plus the, let’s say ’21 – the $19,500 or $26,000 if you’re over 50, plus that $25k, right? So, if you’re over 50 W-2/S corp in 2021 making $100K, you can do a max of $51,000, whereas the SEP is only going to give you the $25,000. So that’s obviously a monster deduction.
Now, if you’re sitting in a position today where you still haven’t filed your return, you’re on extension, you either don’t have a SEP or don’t have a Solo, you should strongly move in the Solo 401(k) direction because, yes, now for ’21’s purposes, the SEP and the Solo is the same; it’s only a profit sharing plan. That’s all you’re going to be able to do. But, going forward, once you’ve made your ’21 contributions, you can start taking advantage of contributions for ’22 and get that employee deferral, get the profit sharing. Also, the Solo 401(k) has a loan feature that lets you borrow $50,000 or 50% of your account value, whatever’s less, and use that loan proceeds for any purpose. It’s a five year loan that you can pay back at least quarterly. Lowest interest rate currently, as of September 2022 is 5.5%. But the good news, you’re paying yourself back. So, you get tax-free, penalty-free use of the money and you’re paying yourself back at 5.5%, which is pretty good rate of return.
Okay, plus, if you’re a real estate investor, there’s a great exemption on the unrelated business taxable income for 401(k)s, where you can use non-recourse leverage to acquire real estate without paying this 37% UBIT tax, which applies to SEP IRAs. Very easy administration of the Solo K; Under $250,000, you have zero IRS reporting requirements, over $250,000, file a 5500-EZ, which, if you’re a client of IRA Financial, we’ll help you do it. It’s literally one page, takes no longer than five to seven minutes.
So, all in all, the Solo K will beat the SEP IRA in any which way. So, if you are looking to set up a plan in 2022 for the ’21 year, take advantage of up to $58,000 or $64,500 deductions still available, I would just set up a Solo. The SECURE Act 1.0 allows us to do that, so take advantage of it. There is a potential that for next year, SECURE Act 2.0 could be passed by the end of the year and signed this law by President Biden and potentially, there’s rumors that SECURE Act 2.0 will, in the final iteration of the bill, have a provision that will allow for employee deferrals to be made for a former year in the current year.
So, if SECURE Act 2.0 was passed now, or last year, for example, you’d still be able to do employee deferrals for ’21 in 2022, so long as you haven’t filed your extension, or haven’t filed your return for the ’21 taxable year. So, everything would be open. However, the law right now is just employer contributions, just 20 or 25%. But you can climb as high as $58,000 or $64,500 if you’re over 50. Of course, you’re going to need income, right? If you made $100K, all you can be able to do is the $20 or $25K if you’re a W-2 and $20K if you’re a sole proprietor. If you made a million, clearly 25% or 20% of a million is $200K. You’re capped at the $58K or $64.5K, so you’ll reach your maximum deduction and be able to reduce your taxable income.
So, hopefully I caught you in time. This is the last monster massive deduction that’s still available. That’s it. SEP IRA or Solo 401(k). Everything else is gone, okay? Everything else has to be done by 12/31/21. So, you have time; you can set up the plan. It takes a couple of days to set up the plan. Again, I would do the Solo vs. SEP. As long as that check is dated before September 15 or October 15, you’re good. You get the contribution, you get the deduction. That money is now in a plan and can grow without tax. If it’s in a Solo, you can borrow against it: 50,000 or 50% of your account value, whatever’s less. You can roll other retirement funds, pretax IRAs, 401(k)s into it, and then use that, not only as a great retirement vehicle, but also as an investment vehicle to do traditional investments, like stocks, but also alternative assets, like real estate or precious metals or cryptos or private business investments. So, it’s a really robust and super powerful retirement plan that you can still take advantage of for the ’21 taxable year.
So, why do you want deductions? Well, deductions reduce taxable income, less money to Uncle Sam, more money in your pocket. Best of all, it’s in a retirement plan. So, will grow without tax by taking advantage of the power of deferral. If you need a little bit of cash, you can always do a loan. SEP IRAs have no loan. SEP IRAs have no Roth options. Solo Ks have Roth options, loan features, plus that employee deferral for 2022 and beyond, which the SEP doesn’t have. So, again, Solo K beats the SEP IRA every which way, and it’s not too late to set one up for 2021 and get yourself massive, monstrous deductions that could really have a super huge impact on your tax position and hopefully save you a lot of tax.
So, accountants, CPAs, tax professionals who’s been listening, reach out to your clients that don’t have retirement plans set up that are self-employed. Trust me, one tax professional to another, go Solo. You’re going to get way more options than just a regular old SEP. If they have set one up, great; make sure they’re making contributions. They can still do it for ’21 in the ’22 taxable year. A lot of people don’t realize the SECURE Act 1.0 was passed, it came into law for 2020. We all know what happened in 2020 – COVID, everything kind of went upside down, but time to focus on this, considering that these potential for $58K or $64,500 deductions are still available and still could have a meaningful impact on your clients or your tax return and tax liability.
Hope this helped. Appreciate you guys spending some time with me today. I hope I saved some people some money. Rather the money go to you than Uncle Sam. Trust me, I love America, but it’s our money. Let’s hold on to as much as we can legally. And again, these deductions are legal deductions. It’s a retirement plan. Do you have a retirement plan from IRA Financial? You will get an opinion letter. So, you know the plan has been pre-approved. Nothing to worry about. Your accountant can help you calculate your deductions; or we can. We have experts. I’ve written two books on this stuff, so trust me, my team is super trained and we literally wrote the book on the Solo K.
So, if you haven’t set up a plan, you’re self-employed/small business owner, you don’t need a Google business, you can be a consultant, a math tutor, even Santa Claus, and as long as you make a little bit of income, you can potentially contribute up to your income and up to the $58K or $64.5K. Reduce your taxable liability and put the money in your pocket instead of the government.
So, thanks again for spending some time today; super appreciate it. I hope you guys enjoyed the podcast and definitely check it out again next week. Take care and have a great day.