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Can a Solo 401(k) Reduce Self-Employment Tax?

Solo 401(k) self-employment tax

One of the more common questions I receive from small business owners who want to learn more about the solo 401(k) plan is whether the plan will help eliminate self-employment tax. The short answer is no.

When you make a contribution to a Solo 401(k) plan, it’s typically after self-employment tax.

What is Self-Employment Tax?

According to the IRS, you are self-employed if you are a sole proprietor (including an independent contractor); a partner in a partnership (including a member of a multi-member LLC), or you’re in business by yourself. A sole proprietor also includes the member of a single-member LLC that is disregarded for federal income tax purposes and members of a qualified joint venture.

Usually, you must pay self-employment tax if you have net earnings from self-employment of $400 or more. Net earnings are calculated by subtracting ordinary and necessary trade or business expenses from the gross income you generate from your trade or business. You can be liable for paying self-employment tax even if you currently receive social security benefits.

If you are self-employed, your FICA (Federal Insurance Contributions Act) tax rate for 2019 is 15.3% on the first $132,900 of net income. It includes an additional 2.9% on the net income in excess of $132,900. In other words, the self-employed person’s FICA tax rate for 2019 includes all of the following:

  • Employee’s portion of the Social Security tax (6.2% of the first $132,900 of net income)
  • Employer’s portion of the Social Security tax (6.2% of the first $132,900 of net income)
  • Employee’s portion of the Medicare tax (1.45% of all net income – no cap or limit on net income)
  • Employer’s portion of the Medicare tax (1.45% of all net income – no cap or limit on net income)

If you have a net income of exactly $132,900 in 2019, you must remit FICA taxes of $20,333.70 ($132,900 x 15.3%).

Self-Employment Can Lower Federal Income Tax

Net earnings from income tax are considered earned income. Income that you earn includes all the taxable income and wages from working. This can be as an employee, or from running or owning a business. It also includes other types of taxable income. Earned income includes:

  • Wages, salaries, tips, and other taxable employee pay
  • Net earnings from self-employment
  • Union strike benefits
  • Long-term disability benefits received prior to minimum retirement age

Therefore, establishing a solo 401(k) plan will help you reduce federal income tax by making pre-tax deductions. However, it will not reduce self-employment tax.

For example, if Tom earns $50,000 and is 45 years old, this is the most Joe can contribute to a solo 401(k) Plan:

  • Net Earnings (before qualified plan deduction) $50,000.00
  • 1402(a)(12)Deduction: $46,175.00
  • Medicare & FICA (TWB of 132900) $7,064.78
  • 1/2 of Self-Employment Tax $3,532.39
  • Self-Employment Income: $46,467.6

The Solo 401(k) for the Self-Employed

A solo 401(k) offers a self-employed business owners the ability to quickly save for retirement. At the same time, you can use your retirement funds to make virtually any type of investment. This includes:

  • Real estate
  • Tax liens
  • Private businesses

You can make investments on your own, without the consent of a custodian. This is completely tax-free. In additional, a Solo 401(k) allows you to make high contribution limits. For 2019, the maximum contribution limit is $56,000 if you’re under 50 years of ago. If you’re over 50, you can contribute up to $62,000 to your Solo 401(k) plan. With the plan, you can also borrow up to $50,000 for any purpose.

Get in Touch

Do you still have questions regarding the Solo 401(k) self-employment tax, or how the Solo 401(k) plan can help you save taxes? Get in touch with IRA Financial Group directly by calling 800-472-0646. You can also fill out the form to speak with one of our on-site 401(k) specialists.

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