Sole Proprietor 401K and Tax Questions

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Topic Author
Chicago60
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Sole Proprietor 401K and Tax Questions

Post by Chicago60 »

This is my first year with a 401K through my sole proprietorship, which I opened solely to take advantage of the ability to contribute to a Roth 401K since I intended to not add to my tax favored accounts, and intended to begin conversions of a sizeable tIRA to a Roth IRA. I now am questioning the wisdom of that position and think having the employer contribute to the 401K makes sense to reduce social security and FICA taxes.

Here are the assumed facts for my sole proprietorship: $100,000 revenue, $20,000 expenses, $14,000 health insurance paid personally in full through 12/31/16, and $24,000 already personally contributed to the Roth component of the 401K at Vanguard. Assume I generate no further revenue to the end of the year, and the entire profit of $80,000 has been paid as salary; and the necessary taxes, i.e., federal, social security, FICA, and state taxes paid to the respective governments.

Questions: (1) As I understand it, I can have the employer contribute approximately $15,000 (20% of the $80,000 profit minus the employee share of social security) to the 401K, but I have no cash in the bank. Since the business is a sole proprietorship, though I have a separate business checking account, can I personally write a check from a personal checking account to Vanguard as the employer portion of the 401K contribution, or can I only contribute if I generate more revenue and do not distribute the new revenue as salary?

(2) If I am concerned whether in 2017 I will generate sufficient revenue for me to deduct the full amount of health insurance on page 1 of my 1040, can I pre-pay some 2017 health insurance premiums in 2016 and deduct those amount?

Thanks for reading, and replying.
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PaddyMac
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Re: Sole Proprietor 401K and Tax Questions

Post by PaddyMac »

As a sole proprietor for many years, our CPA never cared where the money for our SEP or 401k came from. Your business & personal money is best kept in separate account naturally, but you can contribute from anywhere.

Run this calculation to check the max amount
https://docs.zoho.com/sheet/published.d ... 140934898a

Not sure about #2.
beagle1
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Re: Sole Proprietor 401K and Tax Questions

Post by beagle1 »

Unrelated to your question, but incorporating as an S Corp can save you on the FICA. You still have to set a reasonable salary, but under an S Corp not all revenue is necessarily subject to payroll taxes.
Topic Author
Chicago60
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Re: Sole Proprietor 401K and Tax Questions

Post by Chicago60 »

Thanks, Paddy. That was my assumption, but I could not find an answer on the IRS website, and was hoping for something more authoritative and definitive.
Spirit Rider
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Re: Sole Proprietor 401K and Tax Questions

Post by Spirit Rider »

I don't think you will find anything on the IRS website, because there is no difference between a sole proprietor and the individual taxpayer. They are one and the same, for the purposes of a 401k you are both employer and employee. Here is a relevant reference in 401(c)(5)

26 U.S. Code § 401 - Qualified pension, profit-sharing, and stock bonus plans, (c) Definitions and rules relating to self-employed individuals and owner-employees, (5) Contributions on behalf of owner-employees - The term “contribution on behalf of an owner-employee” includes, except as the context otherwise requires, a contribution under a plan
  1. (A) by the employer for an owner-employee, and
    (B) by an owner-employee as an employee
Topic Author
Chicago60
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Re: Sole Proprietor 401K and Tax Questions

Post by Chicago60 »

Spirit Rider wrote:I don't think you will find anything on the IRS website, because there is no difference between a sole proprietor and the individual taxpayer. They are one and the same, for the purposes of a 401k you are both employer and employee. Here is a relevant reference in 401(c)(5)

26 U.S. Code § 401 - Qualified pension, profit-sharing, and stock bonus plans, (c) Definitions and rules relating to self-employed individuals and owner-employees, (5) Contributions on behalf of owner-employees - The term “contribution on behalf of an owner-employee” includes, except as the context otherwise requires, a contribution under a plan
  1. (A) by the employer for an owner-employee, and
    (B) by an owner-employee as an employee
Thanks, Spirit. Sadly, in my mind, that does not help clarify an answer for me. It seems to me that the Roth contribution I already made individually might fall under definition (B), and, by implication, the pre-tax contribution I want the employer (my sole proprietorship) to make on my behalf might need to be made by the employer from employer funds...?
Spirit Rider
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Re: Sole Proprietor 401K and Tax Questions

Post by Spirit Rider »

Chicago60 wrote:
Spirit Rider wrote:
  1. (A) by the employer for an owner-employee, and
    (B) by an owner-employee as an employee
Thanks, Spirit. Sadly, in my mind, that does not help clarify an answer for me. It seems to me that the Roth contribution I already made individually might fall under definition (B), and, by implication, the pre-tax contribution I want the employer (my sole proprietorship) to make on my behalf might need to be made by the employer from employer funds...?
The employer contribution you want to make is from (A) above. As a sole proprietor, you are both the employer and employee. You are one and the same. You file your taxes on an individual using Form 1040 and Schedule C/SE. You make your deferrals as an individual. You make your employer contributions as an individual.

Sure, you can have separate bank accounts for business and individual purposes. In fact, I recommend that. However, it is purely for tracking purposes. You can pay your employer contributions from either your business account or your personal account. It simply doesn't matter.

Now, if you are really an S-Corp or an LLC/S-Corp, that is a whole different matter.
Last edited by Spirit Rider on Thu Sep 08, 2016 4:27 pm, edited 1 time in total.
Spirit Rider
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Re: Sole Proprietor 401K and Tax Questions

Post by Spirit Rider »

Wait a minute, what do you mean by this.
Chicago60 wrote:Assume I generate no further revenue to the end of the year, and the entire profit of $80,000 has been paid as salary; and the necessary taxes, i.e., federal, social security, FICA, and state taxes paid to the respective governments.
A sole proprietor does not receive a salary and does not pay FICA. They are not W-2 employees They receive the entire net business profits as personal funds and pay SE tax, federal tax, state tax, employee deferrals, employer contributions and benefits all from personal funds.

I think this is the fundamental disconnect you have. As far as the IRS is concerned there is no difference between you and the sole proprietorship. Sure you might need an EIN for the i401k, but the sole proprietorship has no separate income/assets. It all belongs to you.

If it makes you feel better, not that it makes any difference, transfer the money back to the business account and pay from there.

If you paid yourself on a W-2 as a sole proprietor, I have no idea what to tell you.
Topic Author
Chicago60
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Re: Sole Proprietor 401K and Tax Questions

Post by Chicago60 »

Spirit Rider wrote:Wait a minute, what do you mean by this.
What I meant by that is lines 4 and 5 (I think) from Schedule SE of my 1040. I did not, and do not, pay myself W-2 wages. Thanks for the question, and concern.
DavidRoseMountain
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Re: Sole Proprietor 401K and Tax Questions

Post by DavidRoseMountain »

Chicago60 wrote: If I am concerned whether in 2017 I will generate sufficient revenue for me to deduct the full amount of health insurance on page 1 of my 1040, can I pre-pay some 2017 health insurance premiums in 2016 and deduct those amount?
Yes you should be able to, because you are considered a cash-basis for deduction purposes.
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