~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

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Derivative
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~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by Derivative » Tue Dec 12, 2017 4:53 am

I have ~100k sole proprietor income. It is my only income. Better to take business deductions or contribute more to solo 401k/roth solo 401k? If I am correct, business deductions lower the amount I can contribute to the solo 401k? Should I always max out any business deductions first (miles, business expenses, etc.) or contribute more to the solo 401k? Is there a middle ground?

I am not sure which one is better and where I can I do more reading on this to understand it better?

smitcat
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by smitcat » Tue Dec 12, 2017 7:17 am

When you have true legitimate business expenses it is always better to take them or plan to take them in following years based upon your current business plan.
After true business expenses , 401K and your personal expenses (costs) if you have extra left over you can look at after tax savings options or paying down a mortgage and/or paying back school or personal loans.

If you are being funded or supported by other means then your business these answers may not be fully applicable.

aristotelian
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by aristotelian » Tue Dec 12, 2017 7:30 am

If you have business expenses, you have to deduct them before calculating your solo 401k limits.

Derivative
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by Derivative » Tue Dec 12, 2017 2:54 pm

aristotelian wrote:
Tue Dec 12, 2017 7:30 am
If you have business expenses, you have to deduct them before calculating your solo 401k limits.
Okay, what if you kept poor track of some business expenses (which I have, e.g. miles) and/or don't have proper documentation for taking them. Do you lose out much if you contribute the money into a solo 401k? What is the math here? If the math makes sense, I don't want to be hunting for months just to get ALL of the business miles and hunt for the documentation if I really can't ever find them. Thank you.

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White Coat Investor
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by White Coat Investor » Tue Dec 12, 2017 3:51 pm

Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
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hawkfan55
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by hawkfan55 » Tue Dec 12, 2017 3:57 pm

Business Deductions reduce your taxable income. A bird in the hand....
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Derivative
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by Derivative » Wed Dec 13, 2017 5:02 am

White Coat Investor wrote:
Tue Dec 12, 2017 3:51 pm
Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
White Coat Investor, can you please show me the math on this (i.e. the math why taking business deductions > contributing to solo/roth 401k)?

TwstdSista
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by TwstdSista » Wed Dec 13, 2017 5:15 am

Business deductions. With $100k income and let's guess $15k in business deductions, you save taxes on that $15k forever. If you are single, that's some combination of 25% and 28% plus the social security tax. That is saved forever, you never have to pay taxes on that amount of money.

If, instead, you put the $15k in your solo 401k, you would save the 25-28% this year, but I believe you still pay the social security tax. AND you would be taxed on that $15k when you withdraw it from your 401k at sometime in the future. If your tax bracket in the future is 15%, then you pay 15% in taxes on that $15k and on it's growth in value.

Basically, putting it in your solo 401k only puts off the tax payment until a later date. Taking the business deduction means you never have to pay taxes on it. (This is my understanding, someone please correct me if I am wrong).

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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by smitcat » Wed Dec 13, 2017 9:46 am

TwstdSista wrote:
Wed Dec 13, 2017 5:15 am
Business deductions. With $100k income and let's guess $15k in business deductions, you save taxes on that $15k forever. If you are single, that's some combination of 25% and 28% plus the social security tax. That is saved forever, you never have to pay taxes on that amount of money.

If, instead, you put the $15k in your solo 401k, you would save the 25-28% this year, but I believe you still pay the social security tax. AND you would be taxed on that $15k when you withdraw it from your 401k at sometime in the future. If your tax bracket in the future is 15%, then you pay 15% in taxes on that $15k and on it's growth in value.

Basically, putting it in your solo 401k only puts off the tax payment until a later date. Taking the business deduction means you never have to pay taxes on it. (This is my understanding, someone please correct me if I am wrong).
This sounds like a good overview but we do not know nearly enough to really help derivative.
We don't know what state he is in.
We do not know his deductions (insurances, car costs, marketing, data and comm, medical, etc)
Depending upon how he owns the car he can likely take a % of the total costs
We do not know how he has been paying his qtrly taxes or to what amount(s)

We do know that he is attempting to solve this a couple of weeks prior to the end of the fiscal year so there will be much to do and much missing.
But another way to look at this is the beginning of 2018 - so perhaps hire someone to help set it up correctly for the new year.
Or if there is a large aversion to spending money in business at least consult someone at SCOPE or the SBDA.

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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by JBTX » Wed Dec 13, 2017 9:56 am

Take the business deductions.

Business reductions reduce both income tax and FICA/self employment tax. Self employed 401k reduces income tax only

Going forward you will eventually owe income taxes on a traditional 401k at regular income tax rates. By taking business deductions you permanently eliminate taxes on the income, because there is no income. If you turn around and invest the money gains will be at lower taxable gains rates vs regular rates of 401k.

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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by JBTX » Wed Dec 13, 2017 10:05 am

smitcat wrote:
Wed Dec 13, 2017 9:46 am
TwstdSista wrote:
Wed Dec 13, 2017 5:15 am
Business deductions. With $100k income and let's guess $15k in business deductions, you save taxes on that $15k forever. If you are single, that's some combination of 25% and 28% plus the social security tax. That is saved forever, you never have to pay taxes on that amount of money.

If, instead, you put the $15k in your solo 401k, you would save the 25-28% this year, but I believe you still pay the social security tax. AND you would be taxed on that $15k when you withdraw it from your 401k at sometime in the future. If your tax bracket in the future is 15%, then you pay 15% in taxes on that $15k and on it's growth in value.

Basically, putting it in your solo 401k only puts off the tax payment until a later date. Taking the business deduction means you never have to pay taxes on it. (This is my understanding, someone please correct me if I am wrong).
This sounds like a good overview but we do not know nearly enough to really help derivative.
We don't know what state he is in.
We do not know his deductions (insurances, car costs, marketing, data and comm, medical, etc)
Depending upon how he owns the car he can likely take a % of the total costs
We do not know how he has been paying his qtrly taxes or to what amount(s)

We do know that he is attempting to solve this a couple of weeks prior to the end of the fiscal year so there will be much to do and much missing.
But another way to look at this is the beginning of 2018 - so perhaps hire someone to help set it up correctly for the new year.
Or if there is a large aversion to spending money in business at least consult someone at SCOPE or the SBDA.
I cannot think of any scenario where 401k would be better than taking legitimate business deductions. It’s a permanent and larger deduction vs a smaller and temporary deferral.

There may be an unlikely scenario with the business deductions, that you make over the approx $120k self employment cap, and the amount you invest incurs capital gains and dividends over the life of the investment, vs the 401k you take out some time in retirement and you somehow swing it such that you stay in the zero percent tax bracket in retirement. That seems highly improbable.

aristotelian
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by aristotelian » Wed Dec 13, 2017 10:10 am

Derivative wrote:
Tue Dec 12, 2017 2:54 pm
aristotelian wrote:
Tue Dec 12, 2017 7:30 am
If you have business expenses, you have to deduct them before calculating your solo 401k limits.
Okay, what if you kept poor track of some business expenses (which I have, e.g. miles) and/or don't have proper documentation for taking them. Do you lose out much if you contribute the money into a solo 401k? What is the math here? If the math makes sense, I don't want to be hunting for months just to get ALL of the business miles and hunt for the documentation if I really can't ever find them. Thank you.
If you don't have good documentation, you shouldn't do either one. If it is a legit expense, you should deduct it. Among other things, you would not get hit with SE tax.

JBTX
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by JBTX » Wed Dec 13, 2017 10:23 am

White Coat Investor wrote:
Tue Dec 12, 2017 3:51 pm
Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
Totally agree with your last paragraph. My guide is whether the deduction is legit. If I drove the miles for business purposes I’m going to deduct the miles even if I don’t have a handwritten notebook with mileages written in with coffee stains on it. I’ll make my best effort to create a mileage log with the best information I have. In the highly unlikely event of audit and my documentation gets rejected then I’ll deal with that.

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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by tractorguy » Wed Dec 13, 2017 10:45 am

I've found that carrying a smart phone makes it easy to create a travel log at any time.

I volunteer at a museum about 30 miles from my house and could not discipline myself to keep a log on the days I drove out there. I go on Wednesdays and Saturdays but not every week because of other comittments. It takes me about an hour when I'm doing my taxes to look at my Google location history and jot down the travel dates. I use Google maps distance as the distance travelled. I haven't been audited but this is a a good faith effort to document my charitable mileage.
Lorne

smitcat
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by smitcat » Wed Dec 13, 2017 10:56 am

JBTX wrote:
Wed Dec 13, 2017 10:23 am
White Coat Investor wrote:
Tue Dec 12, 2017 3:51 pm
Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
Totally agree with your last paragraph. My guide is whether the deduction is legit. If I drove the miles for business purposes I’m going to deduct the miles even if I don’t have a handwritten notebook with mileages written in with coffee stains on it. I’ll make my best effort to create a mileage log with the best information I have. In the highly unlikely event of audit and my documentation gets rejected then I’ll deal with that.
The OP is in a tutoring business with clients that utilize his skill many times. I am sure he has an appointment book/chart with the clients names and billing information on them> All he would need to dos is add the estimated mileage to each client name for 2017 an total.
With that said there should be many more deductions and issues with the overall question he is asking.
If it is really to late for 2017 best get it right for 2018 which will begin in a short 3 weeks.

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White Coat Investor
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by White Coat Investor » Wed Dec 13, 2017 4:14 pm

Derivative wrote:
Wed Dec 13, 2017 5:02 am
White Coat Investor wrote:
Tue Dec 12, 2017 3:51 pm
Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
White Coat Investor, can you please show me the math on this (i.e. the math why taking business deductions > contributing to solo/roth 401k)?
Okay, I'll try.

Your business earns $100K. You also have $20K in business expenses. Or you can put that $20K into a tax-deferred retirement account.

If you take it as a business expense, you don't have to pay SS tax, Medicare tax, or income tax on that $20K. It's totally tax-free to you.

If you don't take the business expense and you put that $20K into a retirement account, you first pay SS tax and Medicare tax on it. Then it goes into the account and grows for a few decades. Then you pull it out. You'll likely pay some type of tax on it. Probably at a lower rate than you saved when you put the money in, but still something.

Paying SS + Medicare + income tax leaves you less money than not paying SS + Medicare + income tax.

The tax benefits of tax-protected growth in a 401(k) are not large enough to overcome that huge tax break except over very, very long time periods.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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White Coat Investor
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by White Coat Investor » Wed Dec 13, 2017 4:14 pm

Derivative wrote:
Wed Dec 13, 2017 5:02 am
White Coat Investor wrote:
Tue Dec 12, 2017 3:51 pm
Business deductions. Every time.

Remember that with a tax-deferred account you're just deferring taxes (yes, you get tax-protected growth and potentially an arbitrage at the end) but with a business expense, that money is never taxed.

The only real question comes in when you're paying as an S Corp and have to decide how much is salary and how much is distribution. More distribution = lower payroll taxes but more salary = largest solo 401(k) contribution. That decision can be tough. But a business deduction? Take it.

Do the best you can with documenting the expenses, but if you actually had them, I'd claim them. If the IRS audits you (low chance) and doesn't accept your documentation (even lower chance) then you may owe some penalties and interest. But I always claim any legitimate deduction I'm due, whether my documentation is perfect or not.
White Coat Investor, can you please show me the math on this (i.e. the math why taking business deductions > contributing to solo/roth 401k)?
Okay, I'll try.

Your business earns $100K. You also have $20K in business expenses. Or you can put that $20K into a tax-deferred retirement account.

If you take it as a business expense, you don't have to pay SS tax, Medicare tax, or income tax on that $20K. It's totally tax-free to you.

If you don't take the business expense and you put that $20K into a retirement account, you first pay SS tax and Medicare tax on it. Then it goes into the account and grows for a few decades. Then you pull it out. You'll likely pay some type of tax on it. Probably at a lower rate than you saved when you put the money in, but still something.

Paying SS + Medicare + income tax leaves you less money than not paying SS + Medicare + income tax.

The tax benefits of tax-protected growth in a 401(k) are not large enough to overcome that huge tax break except over very, very long time periods.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

nolesrule
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by nolesrule » Wed Dec 13, 2017 5:33 pm

Are we talking about employer contributions or employee contributions?

First off, the $20k is gone whether you claim the expense or not. So it has no bearing on the ability to defer additional employee contributions. You either have the cash available to make an employee deferral or you don't.

Secondly, by not paying taxes on the expenses in order to make the contributions, you are essentially paying taxes on the contributions. And you'll pay taxes again upon withdrawal with traditional contributions.

Finally, $20k translates to ~$3700 in employer contributions, all of which are traditional. But you'd be paying taxes on them at both ends because you're not taking the expense deduction and paying much more in taxes. Nothing like paying taxes on $20k to get a tax deferral on $3700. In fact you'd probably end up paying more than $3700 in taxes on the $20k.

TheExMexican
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Re: ~100k sole proprietor income. Better to take business deductions or contribute more to solo 401k?

Post by TheExMexican » Wed Dec 13, 2017 6:19 pm

Let's take a step back and focus on not only 'legitimate' expenses, but also necessary expenses.
nolesrule wrote:
Wed Dec 13, 2017 5:33 pm
...First off, the $20k is gone whether you claim the expense or not....
I have been amazed (appalled?) at how many small businesspeople justify all kinds of unnecessary (but legally deductible) expenses just because "It's a writeoff!"

Here is an example: If I need to buy a computer for my business, I could go buy a $10,000 server and have a rock solid deduction against my business income. However, I can very likely get the same benefit from buying a $2,000 computer. The $10k deduction would make a huge dent on the taxes I owe, but if I can help it, I would much rather have a $2k deduction and either a) put $8k in my tax deferred account, or b) pay taxes on the $8k and spend the remainder on something more fun than an overpriced computer!

My point is that if you have to spend money on your business, you'd better make sure it's a legitimate (deductible) expense, but you'll come out ahead if you don't spend the money in the first place :D

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