Business doing too well...how can I avoid some taxes

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Topic Author
monocle
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Business doing too well...how can I avoid some taxes

Post by monocle »

Hi,

First post. Looking for some advice.

I currently have a full time gov job making about 64,000 per year. My wife is a stay at home mom, hardest job in the world.
I've got about 70,000 cash in the bank.
I have a thrift savings plan (similar to IRA) which I can put 17,000 in per year. I've been putting about 500 per month.

I started a software business as a hobby a couple of years ago and it has recently taken off. Its a single owner LLC. No employees other than myself.

I'm projecting about 210k from the business this year and 330k next year.

My income from the business can be volatile and there is no guarantees that it will stay this high.
So basically... this year I'm in for about 274,000 income. My business expenses are about 2500 per year. I was able to deduct 32,000 last year and can probably do that again this year.

I've sought advice on tax planning from a CPA and from a financial advisor. They recommended either a solo 401k or a defined benefits plan.

Since my income can be volatile I was thinking the solo 401k is the way to go. Thoughts?

Other info for consideration:
Currently closing on a new house that will be the primary residence at 239k 10% down at 3.75 (appraised at 260k, should be able to upgrade it to 330-499k before we sell in 4 years.
Currently own a house, trying to decide to rent or sell. Bought at 260, could probably sell for 200-210, owe 160,000 at 4%
Currently own a piece of land, bought at 72k, owe 45k, trying to sell right now for 100k.

Other than the land and houses we have no debt.
We are going to be moving overseas (from the US) in about 4 years at which time we need about 300k cash available to build a house.

So I'm basically looking for advice on how to maximize tax savings in my current situation without getting screwed in a couple of years when/if my income level drops. Also trying to figure out how to have the big 300k chunk available while not having the money sitting idle in a bank now.
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

Maybe my post was too detailed.

Guess what I am looking for is...
Should I go with a Solo 401k, a Roth Solo 401k, or a defined benefits plan?

I'm expecting a high but maybe volatile self employment income for the next 5-10 years and then basically retiring with a modest retirement income and side jobs to supplement.
In 4 years I get a retirement pension at about 1800 per month which should cover all my living expenses.
nrygiel
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Re: Business doing too well...how can I avoid some taxes

Post by nrygiel »

I would establish a Solo 401k - as it looks like you can maximize the contribution and based on your time horizon for a house you would have enough in there to purchase the house inside the plan (it allows you to purchase real estate) - which means all income and gains generated by the investment would flow-back to the 401k plan tax free. Not sure of the international implications though - that's something to research

you are also able to borrow max of 50% of the value (up to $50,000) if necessary. Plus with TSP - if you're looking at retiring/leaving you can rollover it over and add it into the 401k plan as well. lots of flexibility and less paperwork than a Keogh..
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Duckie
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Re: Business doing too well...how can I avoid some taxes

Post by Duckie »

I'd go Solo 401k, not Roth Solo 401k, so the contributions would be deducted now. I'd also max the TSP, and two Roth IRAs. (This assumes you have no other non-Roth IRAs and will be able to use the Backdoor Roth IRA method without running into the pro-rata rule.)
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

Duckie wrote:I'd go Solo 401k, not Roth Solo 401k, so the contributions would be deducted now. I'd also max the TSP, and two Roth IRAs. (This assumes you have no other non-Roth IRAs and will be able to use the Backdoor Roth IRA method without running into the pro-rata rule.)
Thanks for the tips.
I had never researched the backdoor roth before.
Just want to make sure before I do it...maybe a stupid question, but does the TSP in the eyes of the IRS go toward the pro-rata rule for the IRA to Roth conversion? Or is the TSP just a completely different vehicle?
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Duckie
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Re: Business doing too well...how can I avoid some taxes

Post by Duckie »

The TSP is not an IRA so it doesn't affect the pro-rata rule. In fact, if you had some non-Roth IRA assets that would mess up the backdoor Roth, moving them to the TSP would be an option.
ilmartello
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Re: Business doing too well...how can I avoid some taxes

Post by ilmartello »

You weren't asking this, but I don't see the merits in buying a home if you are selling in 4 years.

I am sure the nytimes rent/buy calculator will say you should rent for the next 4 years.
SGM
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Re: Business doing too well...how can I avoid some taxes

Post by SGM »

I did not choose a DB plan because of the added expenses and the multiple year commitment. Multiple brokerages and MF companies offer solo 401ks without added expenses of administration. With 210k income the maximum contribution including profit sharing for under 50 yo is 50k and 55.5k yearly if you are older. My wife does a little bit of work for my company and almost all of her income goes into the 401k and there is the added fica taxes. However, it is well worth hiring her for the additional tax deferred space and her SS benefits will be a little higher. If she works enough to make 17.5k all of that can go into the solo 401k and then there is her additional profit sharing component. If she keeps the books, makes phone calls and purchases for the business you could certainly justify a salary.

You will have to subtract 401k contributions from your other job from your allowable max in the solo 401k. The max for a DB is 127k with your present income.

I assume you are maximizing your IRA contribution and spousal IRA contribution for a total of 10k yearly if under age 50.
"Let us endeavor, so to live, that when we die, even the undertaker will be sorry." Mark Twain
YDNAL
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Re: Business doing too well...how can I avoid some taxes

Post by YDNAL »

monocle wrote:I currently have a full time gov job making about 64,000 per year. My wife is a stay at home mom, hardest job in the world.

I started a software business as a hobby a couple of years ago and it has recently taken off. Its a single owner LLC. No employees other than myself.

I'm projecting about 210k from the business this year and 330k next year.
Individual 401K
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
Yukon
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Re: Business doing too well...how can I avoid some taxes

Post by Yukon »

How about a SEP IRA? Allows 25% of income contribution and when I researched it in 2003 seemed much simpler to set up/manage than 401ks.
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linuxuser
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Re: Business doing too well...how can I avoid some taxes

Post by linuxuser »

You can put away more money with a 401K.
SEP-IRA is very easy, but I'm sure if you contact Vanguard, they'll be able to make it painless setting up a 401K.
pobox2001
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Re: Business doing too well...how can I avoid some taxes

Post by pobox2001 »

Similar situation here. I've done them all over the years....DB....SEP....solo 401(k).

IMO a solo 401(k) w/profit sharing (PS) is best in your (our) situation. No cost (at least at Vanguard where mine is). No required contributions (if business slows). You can contribute more than a SEP. Depending on your age, you may be able to put more in a DB but it is designed for a multi-year commitment which may be a problem as you said the level of income is uncertain year to year. For these reasons I currently use the 401k/PS plan.
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

Duckie wrote:The TSP is not an IRA so it doesn't affect the pro-rata rule. In fact, if you had some non-Roth IRA assets that would mess up the backdoor Roth, moving them to the TSP would be an option.
Thanks for the info. I'm beginning to see the rough blueprints of an actual plan now. Thanks.
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

ilmartello wrote:You weren't asking this, but I don't see the merits in buying a home if you are selling in 4 years.

I am sure the nytimes rent/buy calculator will say you should rent for the next 4 years.
We outgrew the house we are in now and the new one should provide for a more productive environment for my business. It was also a pretty good deal. We are looking at about 40% equity gain within a few months after some simple remodels and other factors. The other benefit being renting/depreciating the one we are in now, while we are expecting to see property values rise in this area. So the new one is sort of a live-in flip.
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

pobox2001 wrote:Similar situation here. I've done them all over the years....DB....SEP....solo 401(k).

IMO a solo 401(k) w/profit sharing (PS) is best in your (our) situation. No cost (at least at Vanguard where mine is). No required contributions (if business slows). You can contribute more than a SEP. Depending on your age, you may be able to put more in a DB but it is designed for a multi-year commitment which may be a problem as you said the level of income is uncertain year to year. For these reasons I currently use the 401k/PS plan.
I've got my Roth at Vanguard. I checked out the startup requirements for the solo 401(k). It looks fairly simple.

So my current plan is:

50,000 to the Solo 401(k)
17,000 to the TSP
5,000 to the Non Deductible IRA back-doored to a Roth.
Trying to figure out if I can do the same with the Roth for my non-US citizen wife.

So 67,000 tax deferred and 5,000 Roth.
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Duckie
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Re: Business doing too well...how can I avoid some taxes

Post by Duckie »

monocle wrote: So my current plan is:

50,000 to the Solo 401(k)
17,000 to the TSP
5,000 to the Non Deductible IRA back-doored to a Roth.
Trying to figure out if I can do the same with the Roth for my non-US citizen wife.

So 67,000 tax deferred and 5,000 Roth.
Yes, the $50K, $17K, and $5K are allowable, see Example 1 here. (The amounts are for 2011.)

Is your wife a resident alien or a non-resident alien? When reading IRS Publication 590 it looks like resident aliens can have an IRA. I'm not sure about non-resident aliens.
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pteam
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Re: Business doing too well...how can I avoid some taxes

Post by pteam »

You can only do a solo 401k in a business that has no employees?
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

Duckie wrote:

Yes, the $50K, $17K, and $5K are allowable, see Example 1 here. (The amounts are for 2011.)

Is your wife a resident alien or a non-resident alien? When reading IRS Publication 590 it looks like resident aliens can have an IRA. I'm not sure about non-resident aliens.
Ya, she is a resident, but when we move overseas and it is time to withdraw, her status will probably be different, so I need to figure out what happens to the account at that point.
Default User BR
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Re: Business doing too well...how can I avoid some taxes

Post by Default User BR »

Duckie wrote:
monocle wrote:50,000 to the Solo 401(k)
17,000 to the TSP
5,000 to the Non Deductible IRA back-doored to a Roth.
Trying to figure out if I can do the same with the Roth for my non-US citizen wife.
So 67,000 tax deferred and 5,000 Roth.
Yes, the $50K, $17K, and $5K are allowable
Right, as long as the OP understands that the solo 401(k) contributions are strictly employer. The TSP counts as a qualified plan, so the 17k contributed to it wipes out the employee elective deferral amount.


Brian
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

Default User BR wrote: Right, as long as the OP understands that the solo 401(k) contributions are strictly employer. The TSP counts as a qualified plan, so the 17k contributed to it wipes out the employee elective deferral amount.


Brian
Are you saying the 17,000 limit is imposed on the combined employee contributions to the TSP and solo 401(k)? e.g. If I do 7000 into the TSP I can only do 10000 into the solo 401(k).
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baw703916
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Re: Business doing too well...how can I avoid some taxes

Post by baw703916 »

The 401k options count against the $17K limit that applies to the TSP contributions. An SEP IRA can be used to make retirement contributions beyond the $17K limit if one has a sole proprietorship as a side job (basically, it is you the employer, rather than you the employee, who is making the contribution--but if you were to hire another person, you would have to make the same contribution on their behalf, also). The contribution limit in that case will be the lesser of 20% of the net business income, or $50K.

As pointed out in the thread below, the wording is a little ambiguous on how the employee's 401k/TSP contributions might count against the $50K limit. What limits come into play for your allowable SEP IRA contribution is definitely something to discuss with your tax advisor, I'd say.

http://www.bogleheads.org/forum/viewtopic.php?t=43572
Most of my posts assume no behavioral errors.
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zzcooper123
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Re: Business doing too well...how can I avoid some taxes

Post by zzcooper123 »

Read: Jeff Schnepper, Sandy Botkin, June Walker
SGM
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Re: Business doing too well...how can I avoid some taxes

Post by SGM »

Default User BR wrote:
Duckie wrote:
monocle wrote:50,000 to the Solo 401(k)
17,000 to the TSP
5,000 to the Non Deductible IRA back-doored to a Roth.
Trying to figure out if I can do the same with the Roth for my non-US citizen wife.
So 67,000 tax deferred and 5,000 Roth.
Yes, the $50K, $17K, and $5K are allowable
Right, as long as the OP understands that the solo 401(k) contributions are strictly employer. The TSP counts as a qualified plan, so the 17k contributed to it wipes out the employee elective deferral amount.


Brian
A spouse can be included as an employee and the 67k could be doubled.
"Let us endeavor, so to live, that when we die, even the undertaker will be sorry." Mark Twain
Topic Author
monocle
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Re: Business doing too well...how can I avoid some taxes

Post by monocle »

zzcooper123 wrote:Read: Jeff Schnepper, Sandy Botkin, June Walker
Thanks for the tips... just ordered the botkin book... the others seemed a bit unhelpful.. .are there specific books that you are recommending?
Default User BR
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Re: Business doing too well...how can I avoid some taxes

Post by Default User BR »

monocle wrote:Are you saying the 17,000 limit is imposed on the combined employee contributions to the TSP and solo 401(k)? e.g. If I do 7000 into the TSP I can only do 10000 into the solo 401(k).
All elective deferrals to qualified plans. See Example 1 in the IRS link provided above.


Brian
pingo
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Re: Business doing too well...how can I avoid some taxes

Post by pingo »

Not an expert, but the profit sharing portion of the Solo 401k ends up being the same as the max contribution for the SEP-IRA. So for him, it's a draw because he can only personally contribute $17k (plus $5500 catchup contributions at 50+ years of age) maximum combined between the two plans (and I assume he'll max out the TSP). The Solo 401k wins if the goal is to allow Wife to also contribute for herself as an employee covered by the plan. If not, SEP is simplest.

I'm starting to get itchy here. Maybe we really need a post for answering portfolio questions in the suggested format, because I feel like we're giving some of the advice in a vacuum.

Just checking, but the TSP is always a 401k? It's not used for any other purposes, like a 457b?
Default User BR
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Re: Business doing too well...how can I avoid some taxes

Post by Default User BR »

pingo wrote:Just checking, but the TSP is always a 401k? It's not used for any other purposes, like a 457b?
It's neither of those, it's its own thing. However, it's lumped in with some other plans like 401(k) and 403(b) for certain purposes. But to answer the specific question, it's always a defined-contribution plan, not a deferred-compensation plan like 457.


Brian
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Duckie
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Re: Business doing too well...how can I avoid some taxes

Post by Duckie »

The problem with a SEP IRA is that it's an IRA, and that will affect the pro-rata rules if there will be a backdoor Roth IRA.
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baw703916
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Re: Business doing too well...how can I avoid some taxes

Post by baw703916 »

Duckie wrote:The problem with a SEP IRA is that it's an IRA, and that will affect the pro-rata rules if there will be a backdoor Roth IRA.
That may or may not be a problem--you can also backdoor the SEP into a Roth.
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Default User BR
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Re: Business doing too well...how can I avoid some taxes

Post by Default User BR »

baw703916 wrote:That may or may not be a problem--you can also backdoor the SEP into a Roth.
If one is needing to do backdoor Roth, then it's unlikely that a Roth conversion of tax-deferred is a good idea.


Brian
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Re: Business doing too well...how can I avoid some taxes

Post by SeattleCPA »

Here are some ideas from a CPA (me)...
1. I will guess if both a CPA and a financial planner suggested solo 401(k) that that makes sense. (I'm curious why in your situation they didn't suggest SEP because you can also get a lot of the employee elective deferral portion from your job... but they probably saw something in your situation that we don't know about... in fact read next point...)
2. You could look at treating spouse as either partner or employee. That would let you do another 401K set of deductions for wife (and maybe this is reason people suggested solo 401(k)... because it'd let you do two accounts... one for you and one for spouse... )
3. If your wife is a mom, that probably means you have kids? You ought to look at creating a job for your kids in your business if they're minors... you can (assuming job is real) pay a minor up to $5950 a year. That money paid to kids will be deduction to you but not income to them and also not subject to payroll taxes... If you've got two kids and you do this for tail end of 2012, for 2013, and then for 2014, you can maybe turn nearly $36K of the money into tax free income... and maybe pay a nice chunk of college... or kids activities expenses... etc. (Note: Obviously, this gambit doesn't save you money if you give dollar to kids and save $.35 in taxes... what makes sense is when you give a dollar to kids so you don't have to later spend a dollar on college or soccer camp... and then you also save $.35 in taxes.
4. I would try to smooth your income by either moving deductions or income around when possible. When you income spikes up and down, you usually pay more in taxes. E.g., someone who averages $100K a year pays significantly less in taxes than someone with income swinging between $50K and $150K but averaging $100K a year. (This stems from progressivity of rates and credits.)
5. I would make sure that you really get methodical about your tax deductions... I.e., get and use a good accounting system and make sure you really understand the rules for small business tax deductions... This will save you at least a few thousand in taxes, no kidding. Newly successful business owners are often really, er, unsophisticated about this. But things like employing family members (as mentioned earlier), travel, healthcare, etc, can often be deducted and sometimes even deducted twice (once for income tax purposes and another time for self-employment tax purposes) if you're planning ahead.
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YDNAL
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Re: Business doing too well...how can I avoid some taxes

Post by YDNAL »

pingo wrote:The Solo 401k wins if the goal is to allow Wife to also contribute for herself as an employee covered by the plan.
SeattleCPA wrote:2. You could look at treating spouse as either partner or employee. That would let you do another 401K set of deductions for wife (and maybe this is reason people suggested solo 401(k)... because it'd let you do two accounts... one for you and one for spouse... )
That is exactly the reason for an Individual 401K. Consider the OP's income being generated outside a regular full time job.
monocle (OP) wrote:I currently have a full time gov job making about 64,000 per year. My wife is a stay at home mom, hardest job in the world.....

I started a software business as a hobby a couple of years ago and it has recently taken off. Its a single owner LLC. No employees other than myself.

I'm projecting about 210k from the business this year and 330k next year.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
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