CPA recommends to NOT contribute to SEP IRA

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wcombat1911
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CPA recommends to NOT contribute to SEP IRA

Post by wcombat1911 » Mon Feb 19, 2018 6:28 pm

Looking for a little help with understanding this.

Over the past year and a half, I have been helping my father with getting his portfolio in order. I have transferred his annuity plans and consolidated everything with Vanguard in a Lifestyle fund 60/40.

He owns a business and is the only employee. His annual salary is about 90K. His CPA is recommending that he NOT contribute to his SEP IRA this year because "it will not provide any tax benefit this year and he will have to pay taxes on it later". She recommends that he only contribute to his ROTH IRA. Is this terrible advice? He has the means to max both accounts.

Am I missing something here? How would contributing to the SEP not provide any tax benefit for this year? I frequent this forum often and have read numerous of the recommended books on the site. Should we not aim to max all tax advantaged accounts?

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unclescrooge
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Re: CPA recommends to NOT contribute to SEP IRA

Post by unclescrooge » Mon Feb 19, 2018 6:35 pm

Not a cpa, so only speculating here...maybe the cpa is counting all income as dividend income at the lower dividend tax rate.

In order to fund a SEP, this income would need to be wage income, and thus be subject to higher income taxes, plus self employment taxes.
Last edited by unclescrooge on Mon Feb 19, 2018 6:36 pm, edited 1 time in total.

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unclescrooge
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Re: CPA recommends to NOT contribute to SEP IRA

Post by unclescrooge » Mon Feb 19, 2018 6:36 pm

Not a cpa, so only speculating here...maybe the cpa is counting all income as dividend income at the lower dividend tax rate.

In order to fund a SEP, this income would need to be wage income, and thus be subject to higher income taxes, plus self employment taxes.

NightFall
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Re: CPA recommends to NOT contribute to SEP IRA

Post by NightFall » Mon Feb 19, 2018 10:14 pm

It depends. If his marginal tax rate now is less than his expected marginal tax rate in retirement, it's not bad advice at all. It depends a lot on his current tax situation as well as how much he has saved for retirement.

EDIT: To clarify, it's not bad advice to contribute the same amount to a ROTH instead of a traditional in the scenario I mention. It still may be advantageous to put money in a SEP IRA depending on time and how much difference there is between tax rates when the money is put in versus when it is taken out.

randomguy
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Re: CPA recommends to NOT contribute to SEP IRA

Post by randomguy » Mon Feb 19, 2018 10:38 pm

NightFall wrote:
Mon Feb 19, 2018 10:14 pm
It depends. If his marginal tax rate now is less than his expected marginal tax rate in retirement, it's not bad advice at all. It depends a lot on his current tax situation as well as how much he has saved for retirement.

EDIT: To clarify, it's not bad advice to contribute the same amount to a ROTH instead of a traditional in the scenario I mention. It still may be advantageous to put money in a SEP IRA depending on time and how much difference there is between tax rates when the money is put in versus when it is taken out.
In that case the CPA should have his client contributing to a solo ROTH 401(k).:). It seems to me that the only way it can't provide a benefit this year if your dad isn't paying any income tax. I suppose that is possible on 90k of income but it seems like a stretch. But obviously we are all pretty much guessing as we don't know the exact details. The CPA could be right. Or they could be clueless.

Spirit Rider
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Spirit Rider » Mon Feb 19, 2018 11:04 pm

You should provide more information.

You stated; "His annual salary is $90K." If that an actual W-2 salary in an S-Corp, what is the distribution? Or is that business profit in a sole proprietorship?

What is his MAGI, tax filing status and marginal tax rate (fed/state/local)? Does he make the maximum contribution or some fixed amount?

You should also ask what were the CPA's specific reasons. Speculation is going to be far less effective.

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celia
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Re: CPA recommends to NOT contribute to SEP IRA

Post by celia » Mon Feb 19, 2018 11:35 pm

If he contributed to a SEP IRA last year, what is different about this year? Is the CPA saying it is NOT a deductible contribution, thus it won't decrease his taxes?

We need more information.

Northern Flicker
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Northern Flicker » Tue Feb 20, 2018 12:06 am

His CPA is recommending that he NOT contribute to his SEP IRA this year because "it will not provide any tax benefit this year and he will have to pay taxes on it later". She recommends that he only contribute to his ROTH IRA. Is this terrible advice? He has the means to max both accounts.

Am I missing something here?
Yes. You should be posing this question to the CPA, e.g. asking why there would be no tax benefit this year.
Index fund investor since 1987.

Topic Author
wcombat1911
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Re: CPA recommends to NOT contribute to SEP IRA

Post by wcombat1911 » Wed Feb 21, 2018 11:10 am

Thanks for the responses. I will put together some questions for him to ask the CPA. I will mention that looking at his tax returns in the past, she sets it up so that his W2 wages are about 60K and the business profit around 30K. The business is set up as a LLC.

Spirit Rider
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Spirit Rider » Wed Feb 21, 2018 12:03 pm

Marital status and taxable income would be important information.

The 2017 MFJ 15%/25% bracket changeover is at $75K.

If he is below that the CPA may be giving good advice. I too would prioritize Roth IRAs for him and his spouse and if he has extra money to invest do that in the SEP IRA.

If he is over that. I would make whatever contribution to the SEP IRA that is necessary to get taxable income down to $75K and then contribute to Roth IRAs.

It is not an all or nothing situation.

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Epsilon Delta
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Epsilon Delta » Wed Feb 21, 2018 1:49 pm

wcombat1911 wrote:
Mon Feb 19, 2018 6:28 pm
His CPA is recommending that he NOT contribute to his SEP IRA this year because "it will not provide any tax benefit this year and he will have to pay taxes on it later". She recommends that he only contribute to his ROTH IRA. Is this terrible advice? He has the means to max both accounts.
Do you mean this year, 2018, or last year, 2017?

For 2017 this may make sense. For 2018 consider making a SEP contribution in 2018 and converting to a Roth in 2018. Mark you calendar to think about this in November. (you can't do this for 2017 since it's too late to convert in 2017).

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simplesimon
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Re: CPA recommends to NOT contribute to SEP IRA

Post by simplesimon » Wed Feb 21, 2018 1:58 pm

Make sure you're distinguishing between employer vs. employee contributions.

The business can contribute to the SEP IRA while, as an individual, he contributes to a Roth IRA.

I find it odd that a one-man shop organizes as an LLC with himself as a W-2 employee. I may be missing something: what are the tax benefits here vs having it all count on his tax return as business income?

Spirit Rider
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Spirit Rider » Wed Feb 21, 2018 3:51 pm

simplesimon wrote:
Wed Feb 21, 2018 1:58 pm
I find it odd that a one-man shop organizes as an LLC with himself as a W-2 employee. I may be missing something: what are the tax benefits here vs having it all count on his tax return as business income?
He gets to avoid SE tax on the amount of S-Corp distributions and retirement plan contributions.

With $60K W-2 wages, $15K SEP IRA contributions and $30K distributions. He will only pay 15.3% FICA (7.65% employee/7.65% employer) on $60K = $9,180. As an sole proprietor he would pay 15.3% SE tax on $105K = $16,065.

They would both pay income taxes on approximately the same income ($90K), but which would you prefer to pay, $9,180 or $16,065 for Social Security and Medicare taxes?

aristotelian
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Re: CPA recommends to NOT contribute to SEP IRA

Post by aristotelian » Wed Feb 21, 2018 3:57 pm

Maybe she means that he should be contributing to a Solo 401k?

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simplesimon
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Re: CPA recommends to NOT contribute to SEP IRA

Post by simplesimon » Wed Feb 21, 2018 4:04 pm

Spirit Rider wrote:
Wed Feb 21, 2018 3:51 pm
simplesimon wrote:
Wed Feb 21, 2018 1:58 pm
I find it odd that a one-man shop organizes as an LLC with himself as a W-2 employee. I may be missing something: what are the tax benefits here vs having it all count on his tax return as business income?
He gets to avoid SE tax on the amount of S-Corp distributions and retirement plan contributions.

With $60K W-2 wages, $15K SEP IRA contributions and $30K distributions. He will only pay 15.3% FICA (7.65% employee/7.65% employer) on $60K = $9,180. As an sole proprietor he would pay 15.3% SE tax on $105K = $16,065.

They would both pay income taxes on approximately the same income ($90K), but which would you prefer to pay, $9,180 or $16,065 for Social Security and Medicare taxes?
Hm okay, I think I get the avoiding SE tax on the distributions, but how is he able to contribute $15k to an SEP IRA?

My wife is a 1099 employee with income highly variable and files as a sole proprietor. Wondering if saving on SE tax would be applicable in our situation. I'm guessing with the pass through entity tax rules that advantage will be negated to some extent?

Spirit Rider
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Re: CPA recommends to NOT contribute to SEP IRA

Post by Spirit Rider » Wed Feb 21, 2018 5:57 pm

simplesimon wrote:
Wed Feb 21, 2018 4:04 pm
Hm okay, I think I get the avoiding SE tax on the distributions, but how is he able to contribute $15k to an SEP IRA?
The maximum employer contribution to either a SEP IRA or a one-participant 401k are the same. The statutory limit is 25% of compensation. For an S-Corp owner this is generally W-2 Box 1 - Box 12 pre-tax deferrals. 25% of $60K = $15K.
My wife is a 1099 employee with income highly variable and files as a sole proprietor. Wondering if saving on SE tax would be applicable in our situation. I'm guessing with the pass through entity tax rules that advantage will be negated to some extent?
It depends on what her net earnings from self-employment and reasonable salary would be. People have this idea that S-Corps are only an advantage to higher income individuals. However, the S-Corp is optimal when the net earnings from self-employment are at the Social Security maximum wage base (2018 = $128,400). It would generally be useful from 1/2 this amount to 1 1/2 this amount. From 1 1/2 - 2 1/2 it becomes much less valuable and then gets increasingly valuable at 2 1/2 and beyond.

The key factor in the pass-thru deduction is going to be taxable income. Especially, MFJ with substantial incomes.

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