2021 Tax Question. Husband's W2 and wife's 1099. SEP IRA or alternate options?

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newbogleheader
Posts: 1
Joined: Tue Apr 20, 2021 9:56 pm

2021 Tax Question. Husband's W2 and wife's 1099. SEP IRA or alternate options?

Post by newbogleheader »

Hello BHs,

Below are the details of the situation we find ourselves in for the year 2021.

My 2021 income details -

Total income - 145k
W2 Employee
401k contributions - 19.5k
Roth IRA contributions - 6k
HSA contributions - 5.2k
Total taxable income - 120.3k (Total income - 401k - HSA)

Wife's 2021 income details

Total income - 107k
1099 (Self Employed)
Traditional IRA contributions - 6k
Work expenses - 10k
Total taxable income - 97k (Total income - work expenses). The tIRA does not count towards deductions as the net taxable income is above 208k.

Household net taxable income = 120.3k + 97k = 217.3k

Our goal is to bring the Household net taxable income below 198k and as a result reduce our tax liability as much as possible.

The 2021 eligibility limit/range for roth/traditional IRA contributions for married filing jointly couples is 198k - 208k. I have already contributed 6k to my Roth IRA, at the beginning of 2021, and am looking at a potential 6% penalty.

We read about the possibility of opening a new SEP IRA account for my wife. Here is what the fidelity website says about SEP IRA (https://www.fidelity.com/retirement-ira ... ss/sep-ira )

Who is eligible - Self-employed individuals or small-business owners, primarily those with only a few employees.2 Must be a sole proprietor,
a business owner, in a partnership, or earn self-employment income by providing a service.

Tax benefits - Earnings are tax-deferred and contributions are tax-deductible.

Who contributes - Funded by employer contributions. (In our case, my wife will be the employer as she is self employed)

Contribution amounts - Must be made by the employer and can vary each year between 0% and 25% of compensation (maximum
$57,000 for 2020 and $58,000 for 2021). Each eligible employee must receive the same percentage.


Our understanding is that by contributing 20k - 25k to a new SEP IRA account, we can bring our Household net taxable income down to 197.3k - 192.3k, thus getting us under the 198k mark for the year. 20k - 25k is lesser than 25% of my wife's total compensation (107k)

Our questions -

1. What do BHs think about this plan? Are we overlooking anything here?
2. Is there a better/alternate way to do this? (self employed 401k plan? The max contribution limit is 19.5k for 2021)
3. Do we avoid penalties on my Roth IRA contributions by executing this plan? If not, shall I withdraw my contributions to Roth IRA?

Please advice. Thank you!
User avatar
MP123
Posts: 2407
Joined: Thu Feb 16, 2017 3:32 pm

Re: 2021 Tax Question. Husband's W2 and wife's 1099. SEP IRA or alternate options?

Post by MP123 »

Welcome to Bogleheads!

Is your wife a sole proprietor? Then the max SEP-IRA contribution is 20% of Net business income - 1/2 self employment tax. For an S-Corp you can use 25% of W2 compensation.

A solo 401k would allow the same "employer" contribution as the SEP, but it also allows an "employee" deferral of up to $19.5k on top of that. So the solo 401k has considerably higher contribution limits at the expense of a little more paperwork.

Either the SEP or solo 401k would be a good choice, but the solo 401k would let you put away enough to get comfortably below the Roth IRA phaseout range, the SEP might not be enough.
SuzBanyan
Posts: 882
Joined: Thu Jun 02, 2016 11:20 am

Re: 2021 Tax Question. Husband's W2 and wife's 1099. SEP IRA or alternate options?

Post by SuzBanyan »

MP123 wrote: Thu Jan 13, 2022 2:36 pm Welcome to Bogleheads!

Is your wife a sole proprietor? Then the max SEP-IRA contribution is 20% of Net business income - 1/2 self employment tax. For an S-Corp you can use 25% of W2 compensation.

A solo 401k would allow the same "employer" contribution as the SEP, but it also allows an "employee" deferral of up to $19.5k on top of that. So the solo 401k has considerably higher contribution limits at the expense of a little more paperwork.

Either the SEP or solo 401k would be a good choice, but the solo 401k would let you put away enough to get comfortably below the Roth IRA phaseout range, the SEP might not be enough.
There is also another issue. Although a 401k can be opened after the plan year to which it related, the employee is required to notify the employer before the plan year ends how much should be deferred by the employee. While some feel that this is merely a technicality, it does appear to be a requirement for all 401ks, even solo 401ks. That would mean that no employee contribution could be made by your spouse for the 401k for 2021.

There is also the question of whether it would be better for her 401k employee deferral to be made to a Roth 401k. A traditional contribution reduces the business income which reduces the QBI deduction. This makes the deferral to a traditional 401k less valuable, which makes the Roth 401k deferral the right choice for more taxpayers.

It may be better to fix your issues with 2021 IRA contributions (your Roth and your spouses’s traditional). It may make sense to recharacterize your Roth contribution as a traditional IRA contribution, then convert it to a Roth. And your spouse could convert the non deductible traditional IRA to a Roth. Your success in getting funds units a Roth by this “back door” will depend on whether you have prior balances in your traditional IRAs.
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