Benefits of becoming an independent contractor

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Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Benefits of becoming an independent contractor

Post by cbr shadow » Mon May 13, 2019 5:22 pm

I'm considering becoming an independent contractor in a similar job that I'm currently employed. For purposes of this thread, assume non-compete isn't an issue. It isn't an issue and I'd like to stay on topic.

My goal is to compare:
A) Staying with my current company
vs
B) Starting a single-member LLC and starting out on my own

Assuming I do option B, I'm certain that I already have a contract lined up.


Situation A:
Salary: $100k
401k Match 5%
Medical Insurance & Dental - paid for by the company

Situation B:
Start Single Member LLC
Contract amount: $180k
Medical Insurance & Dental: Can jump on my wife's for $150/month. Similar insurance as situation A

Notes;
- Both situations are equally secure.
- My wife makes a high enough income to sustain us, so I'm ok with some risk (36 year old DINK's, HCOL area (SF Bay Area), maybe work on having a kid next year)


Questions:
1) My understanding is that in "Situation B" I could open a Solo 401k and stash $54,000 pretax in it per year. I'd also have lots of things that I could write off (commute, home office, etc).

2) Are there other tax or retirement benefits to either situation that I'm missing?

I really appreciate any help/advice.

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southerndoc
Posts: 959
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Location: Atlanta

Re: Benefits of becoming an independent contractor

Post by southerndoc » Mon May 13, 2019 5:30 pm

Option B will be better for retirement savings. Your current employment at $100k/yr with $19,000/yr contributions to 401(k) and 5% match won't compare to the amount you can put away with a Solo 401(k).

However, when using one of the online calculators, I found that $180k salary would give you a little over $52k in contributions. Mileage for commutes can be tough to deduct, and I would strongly suggest you talk with a CPA before doing this (if you do your own taxes). Home office deductions are often unclaimed by people who can easily claim them for fear of audit. I personally write off my home office (consulting gig).

niceguy7376
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Joined: Wed Jul 10, 2013 2:59 pm
Location: Metro ATL

Re: Benefits of becoming an independent contractor

Post by niceguy7376 » Mon May 13, 2019 5:38 pm

cbr shadow wrote:
Mon May 13, 2019 5:22 pm
Situation B:
Start Single Member LLC
Do you need LLC?

Luckywon
Posts: 445
Joined: Tue Mar 28, 2017 10:33 am

Re: Benefits of becoming an independent contractor

Post by Luckywon » Mon May 13, 2019 5:40 pm

cbr shadow wrote:
Mon May 13, 2019 5:22 pm
I'm considering becoming an independent contractor in a similar job that I'm currently employed. For purposes of this thread, assume non-compete isn't an issue. It isn't an issue and I'd like to stay on topic.

My goal is to compare:
A) Staying with my current company
vs
B) Starting a single-member LLC and starting out on my own

Assuming I do option B, I'm certain that I already have a contract lined up.


Situation A:
Salary: $100k
401k Match 5%
Medical Insurance & Dental - paid for by the company

Situation B:
Start Single Member LLC
Contract amount: $180k
Medical Insurance & Dental: Can jump on my wife's for $150/month. Similar insurance as situation A

Notes;
- Both situations are equally secure.
- My wife makes a high enough income to sustain us, so I'm ok with some risk (36 year old DINK's, HCOL area (SF Bay Area), maybe work on having a kid next year)


Questions:
1) My understanding is that in "Situation B" I could open a Solo 401k and stash $54,000 pretax in it per year. I'd also have lots of things that I could write off (commute, home office, etc).

2) Are there other tax or retirement benefits to either situation that I'm missing?

I really appreciate any help/advice.

If you go the LLC route and have a lot of deductions, you will be around the limit where you may not be able to make the full 56k solo 401k pretax deduction. However, you can make up the difference with an aftertax contribution which you can rollover to a Roth 401k or IRA (mega backdoor Roth), providing your solo 401k is set up to allow these, so that is something to keep in mind if you do go the LLC route and are setting up your solo 401k.

Good luck.

bhsince87
Posts: 2276
Joined: Thu Oct 03, 2013 1:08 pm

Re: Benefits of becoming an independent contractor

Post by bhsince87 » Mon May 13, 2019 5:46 pm

I've been toying with this idea myself, so I'll jump in with another question:

Does anyone know if the recent 20% net profit exclusion applies to contract work like this?
Retirement: When you reach a point where you have enough. Or when you've had enough.

fyre4ce
Posts: 218
Joined: Sun Aug 06, 2017 11:29 am

Re: Benefits of becoming an independent contractor

Post by fyre4ce » Mon May 13, 2019 6:00 pm

If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.

Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Re: Benefits of becoming an independent contractor

Post by cbr shadow » Mon May 13, 2019 6:06 pm

southerndoc wrote:
Mon May 13, 2019 5:30 pm
Option B will be better for retirement savings. Your current employment at $100k/yr with $19,000/yr contributions to 401(k) and 5% match won't compare to the amount you can put away with a Solo 401(k).

However, when using one of the online calculators, I found that $180k salary would give you a little over $52k in contributions. Mileage for commutes can be tough to deduct, and I would strongly suggest you talk with a CPA before doing this (if you do your own taxes). Home office deductions are often unclaimed by people who can easily claim them for fear of audit. I personally write off my home office (consulting gig).
All good info, thank you. I do currently use a CPA for filing taxes.
Why is mileage for commutes tough to deduct? I assumed it was simple and based on total commute miles which I'd have to accurately track.

I'm trying to get a good idea of "Is this worth it" to go through the trouble of making a change. If in the end there's not a big payoff for doing independent contracting I'll continue to plug along at my current employer.

Is it a fair rough estimate to think I'd make $80k more as an independent contractor, or will my tax situation help/hurt that number overall?
Are there any other vehicles for saving money that would be available as a "business owner" that aren't currently available as an employee?

Thanks!

Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Re: Benefits of becoming an independent contractor

Post by cbr shadow » Mon May 13, 2019 6:08 pm

fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.
Thank you for taking the time.
I need to review your post closely to fully understand everything, but it gives me a lot to consider.

FrugalMaineah
Posts: 1
Joined: Fri Dec 07, 2018 7:52 am

Re: Benefits of becoming an independent contractor

Post by FrugalMaineah » Mon May 13, 2019 6:13 pm

bhsince87 wrote:
Mon May 13, 2019 5:46 pm
I've been toying with this idea myself, so I'll jump in with another question:

Does anyone know if the recent 20% net profit exclusion applies to contract work like this?
Yes, for Independent Contractors you get the new QBI deduction. This nice deduction, along with putting away tax deferred income up to 61k/yr(50 and over), are a great benefit for being Independent.

Luckywon
Posts: 445
Joined: Tue Mar 28, 2017 10:33 am

Re: Benefits of becoming an independent contractor

Post by Luckywon » Mon May 13, 2019 6:18 pm

cbr shadow wrote:
Mon May 13, 2019 6:08 pm
fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.
Thank you for taking the time.
I need to review your post closely to fully understand everything, but it gives me a lot to consider.
A great many variables are in play when calculating your QBI deduction including your spouse's wages. Understanding them all is a major project. This calculator may help you as it returns proforma tax calculations for the inputs relevant to the QBI deduction. It is not super obvious but you have to click on the fields "entity selection" and "calculations" to see the results.

https://proconnect.intuit.com/tax-refor ... alculator/

fyre4ce
Posts: 218
Joined: Sun Aug 06, 2017 11:29 am

Re: Benefits of becoming an independent contractor

Post by fyre4ce » Mon May 13, 2019 6:23 pm

bhsince87 wrote:
Mon May 13, 2019 5:46 pm
I've been toying with this idea myself, so I'll jump in with another question:

Does anyone know if the recent 20% net profit exclusion applies to contract work like this?
In general, yes, as an independent contractor you should be able to take the Section 199A deduction. The rules are different whether you're a pass-through corporation or a sole proprietor.

As a sole proprietor, you are allowed to deduct ALL business earnings (gross receipts minus deductions). You also have to pay payroll tax on all net business earnings.

If you're incorporated, you only take the deduction on net business profit (gross receipts, minus wages, employer 401k contributions, deductions) so it's a smaller deduction. But you also only pay payroll taxes on the wages.

You also need to check to see whether you're phased out of 199A deduction as a "specified service corporation." If you're an accountant, doctor, etc then the deduction gets phased out at a taxable income (AFTER below-the-line deductions) starting at $157.5k for single filers or $315k for MFJ. Phase-out range is $50k single and $100k MFJ. If you're not a specified service corporation then there's no income limit on the 199A deduction.

aristotelian
Posts: 5671
Joined: Wed Jan 11, 2017 8:05 pm

Re: Benefits of becoming an independent contractor

Post by aristotelian » Mon May 13, 2019 6:35 pm

OP, you can't just pick your status. You mentioned this would be a "job" for your current employer. That likely makes you an employee. Are you sure this is legal?

cadreamer2015
Posts: 793
Joined: Wed Apr 08, 2015 1:52 pm
Location: North County San Diego

Re: Benefits of becoming an independent contractor

Post by cadreamer2015 » Mon May 13, 2019 7:09 pm

If you have a home office that is your principal place of work you probably won’t have any commute expenses, deductible or not. If you travel to various client locations to perform services at various times I wouldn’t call those commuting expenses and they might well be deductible.

The 20% QBI deduction is a boon for independent contractors. It probably saved me $6,500 in federal taxes in 2018.

You can put away a lot in a solo 401k account as an independent contractor. Not sure if you could put away the entire $56k max in employee and employer solo 401k contributions with $180k gross revenue, but there are several calculators out there that can give you a more precise answer.

Health insurance (including Long Term Care Insurance) premiums may be deductible against your business income.

There are many threads on whether an LLC is necessary or useful as a solo independent contractor. Search them. My take is that unless your potential clients require you to have an LLC in order to invoice them, then an LLC is not worth the hassle, especially as it very probably doesn’t shield you from liability from your own actions. YMMV and it may be worth speaking to your own attorney if they have knowledge of business law.
De gustibus non est disputandum

iasw
Posts: 202
Joined: Mon Dec 05, 2016 2:02 pm

Re: Benefits of becoming an independent contractor

Post by iasw » Mon May 13, 2019 7:58 pm

Don't forget factoring in vacation, holiday and PTO to your contractor rate. I'm assuming you get those benefits at your w2 job and nothing for contract work.

bhsince87
Posts: 2276
Joined: Thu Oct 03, 2013 1:08 pm

Re: Benefits of becoming an independent contractor

Post by bhsince87 » Mon May 13, 2019 8:39 pm

fyre4ce wrote:
Mon May 13, 2019 6:23 pm
bhsince87 wrote:
Mon May 13, 2019 5:46 pm
I've been toying with this idea myself, so I'll jump in with another question:

Does anyone know if the recent 20% net profit exclusion applies to contract work like this?
In general, yes, as an independent contractor you should be able to take the Section 199A deduction. The rules are different whether you're a pass-through corporation or a sole proprietor.

As a sole proprietor, you are allowed to deduct ALL business earnings (gross receipts minus deductions). You also have to pay payroll tax on all net business earnings.

If you're incorporated, you only take the deduction on net business profit (gross receipts, minus wages, employer 401k contributions, deductions) so it's a smaller deduction. But you also only pay payroll taxes on the wages.

You also need to check to see whether you're phased out of 199A deduction as a "specified service corporation." If you're an accountant, doctor, etc then the deduction gets phased out at a taxable income (AFTER below-the-line deductions) starting at $157.5k for single filers or $315k for MFJ. Phase-out range is $50k single and $100k MFJ. If you're not a specified service corporation then there's no income limit on the 199A deduction.
Thanks! I would probably go sole proprietor route.
Retirement: When you reach a point where you have enough. Or when you've had enough.

TBillT
Posts: 668
Joined: Sat Sep 17, 2011 1:43 pm

Re: Benefits of becoming an independent contractor

Post by TBillT » Mon May 13, 2019 10:12 pm

I've done the sole proprietor option after I retired.
I was a bit PO'ed at high self-employment taxes (in the $100-$135k income range), but the new business tax cuts now address that issue to some extent, so it's a good time to be a contractor. It figures, as now I am not doing much work anymore.

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Mon May 13, 2019 10:23 pm

niceguy7376 wrote:
Mon May 13, 2019 5:38 pm
cbr shadow wrote:
Mon May 13, 2019 5:22 pm
Situation B:
Start Single Member LLC
Do you need LLC?
I second this question. If you are just providing professional services; an LLC is often unnecessary, provides little benefit and is possibly counter-productive.

Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Re: Benefits of becoming an independent contractor

Post by cbr shadow » Mon May 13, 2019 10:40 pm

Spirit Rider wrote:
Mon May 13, 2019 10:23 pm
niceguy7376 wrote:
Mon May 13, 2019 5:38 pm
cbr shadow wrote:
Mon May 13, 2019 5:22 pm
Situation B:
Start Single Member LLC
Do you need LLC?
I second this question. If you are just providing professional services; an LLC is often unnecessary, provides little benefit and is possibly counter-productive.
Good points, I don't think I need LLC. MY CPA gave me several options and that sounded the best based on what he had said, but this was just a preliminary discussion.

Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Re: Benefits of becoming an independent contractor

Post by cbr shadow » Mon May 13, 2019 10:42 pm

aristotelian wrote:
Mon May 13, 2019 6:35 pm
OP, you can't just pick your status. You mentioned this would be a "job" for your current employer. That likely makes you an employee. Are you sure this is legal?
My current employer is a company that staffs me under a contract at a larger company. I won't sidetrack this thread with this part of the discussion, but to keep things short, I'm able to get a very similar contract by leaving my current company, without having non-compete issues.

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Tue May 14, 2019 8:57 am

Luckywon wrote:
Mon May 13, 2019 5:40 pm
cbr shadow wrote:
Mon May 13, 2019 5:22 pm
I'm considering becoming an independent contractor in a similar job that I'm currently employed. For purposes of this thread, assume non-compete isn't an issue. It isn't an issue and I'd like to stay on topic.

My goal is to compare:
A) Staying with my current company
vs
B) Starting a single-member LLC and starting out on my own

Assuming I do option B, I'm certain that I already have a contract lined up.


Situation A:
Salary: $100k
401k Match 5%
Medical Insurance & Dental - paid for by the company

Situation B:
Start Single Member LLC
Contract amount: $180k
Medical Insurance & Dental: Can jump on my wife's for $150/month. Similar insurance as situation A

Notes;
- Both situations are equally secure.
- My wife makes a high enough income to sustain us, so I'm ok with some risk (36 year old DINK's, HCOL area (SF Bay Area), maybe work on having a kid next year)


Questions:
1) My understanding is that in "Situation B" I could open a Solo 401k and stash $54,000 pretax in it per year. I'd also have lots of things that I could write off (commute, home office, etc).

2) Are there other tax or retirement benefits to either situation that I'm missing?

I really appreciate any help/advice.

If you go the LLC route and have a lot of deductions, you will be around the limit where you may not be able to make the full 56k solo 401k pretax deduction. However, you can make up the difference with an aftertax contribution which you can rollover to a Roth 401k or IRA (mega backdoor Roth), providing your solo 401k is set up to allow these, so that is something to keep in mind if you do go the LLC route and are setting up your solo 401k.

Good luck.
The after tax contribution to rollover to Roth IRA will be prorated? my understanding is the ira looks at the combined total of pre tax and after tax iras. say you have $100k pre tax Ira and you want to fund 50k after tax to Roth rollover. The Ira will tax at income part of Roth IRA that is greater than the combined accounts.

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Tue May 14, 2019 1:39 pm

Almond wrote:
Tue May 14, 2019 8:57 am
The after tax contribution to rollover to Roth IRA will be prorated? my understanding is the ira looks at the combined total of pre tax and after tax iras. say you have $100k pre tax Ira and you want to fund 50k after tax to Roth rollover. The Ira will tax at income part of Roth IRA that is greater than the combined accounts.
The direct rollover of employee after-tax contributions and earnings to a Roth IRA, do not go through a traditional IRA, are not reported on Form 8606 and are not subject to any pro-rata taxation.

The pre-tax earnings are taxable when rolled over to a Roth IRA, but not when rolled over to a traditional IRA with a split rollover. Most plans that support employee after-tax contributions and in-service rollovers of such also accept IRA rollovers. You can then rollover the pre-tax assets in the traditional IRA back into the plan, preventing any future pro-rata taxation.

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Wed May 15, 2019 8:11 am

Spirit Rider wrote:
Tue May 14, 2019 1:39 pm
Almond wrote:
Tue May 14, 2019 8:57 am
The after tax contribution to rollover to Roth IRA will be prorated? my understanding is the ira looks at the combined total of pre tax and after tax iras. say you have $100k pre tax Ira and you want to fund 50k after tax to Roth rollover. The Ira will tax at income part of Roth IRA that is greater than the combined accounts.
The direct rollover of employee after-tax contributions and earnings to a Roth IRA, do not go through a traditional IRA, are not reported on Form 8606 and are not subject to any pro-rata taxation.

The pre-tax earnings are taxable when rolled over to a Roth IRA, but not when rolled over to a traditional IRA with a split rollover. Most plans that support employee after-tax contributions and in-service rollovers of such also accept IRA rollovers. You can then rollover the pre-tax assets in the traditional IRA back into the plan, preventing any future pro-rata taxation.
So if I understand anything rollover in after tax contributions are not pro-rate taxation. Are you saying money has to go direct to Roth IRA and can not be done via backdoor? I know direct Roth contributions are not prorated, but you seemed to suggest you can do indirect and then rollover and still not subject to pro-rate

I don’t get your second paragraph. can you give an example.

Thank you

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Wed May 15, 2019 8:24 am

fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.

Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.

Thank you

Greenman72
Posts: 325
Joined: Fri Nov 01, 2013 2:17 pm

Re: Benefits of becoming an independent contractor

Post by Greenman72 » Wed May 15, 2019 11:08 am

Haven't read all the replies, but here is my ultrashort take on the matter:

Assuming you have work to do, and won't starve....independent contractor is almost always better than employee. In fact, assuming that you're making enough to cover the additional costs of being a contractor (continuing ed, professional license, insurance, self-employment tax, office equipment), there are a lot of other benefits--such as the ability to write off a home office or a car or a "shareholder's meeting" in Vegas or Orlando. You get higher potential retirement contributions. You can structure your business any way you want. You can create a corporation or LLC that can be passed on to your heirs (if they're interested in selling or carrying on the business). And so on....

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Wed May 15, 2019 12:19 pm

Almond wrote:
Wed May 15, 2019 8:11 am
Spirit Rider wrote:
Tue May 14, 2019 1:39 pm
The direct rollover of employee after-tax contributions and earnings to a Roth IRA, do not go through a traditional IRA, are not reported on Form 8606 and are not subject to any pro-rata taxation.

The pre-tax earnings are taxable when rolled over to a Roth IRA, but not when rolled over to a traditional IRA with a split rollover. Most plans that support employee after-tax contributions and in-service rollovers of such also accept IRA rollovers. You can then rollover the pre-tax assets in the traditional IRA back into the plan, preventing any future pro-rata taxation.
So if I understand anything rollover in after tax contributions are not pro-rate taxation. Are you saying money has to go direct to Roth IRA and can not be done via backdoor? I know direct Roth contributions are not prorated, but you seemed to suggest you can do indirect and then rollover and still not subject to pro-rate
It is not that the rollover has to go directly to a Roth IRA, just that it can. However, if you rollover the employee after-tax account to a traditional IRA and then do a Roth conversion. That Roth conversion is subject to pro-rata taxation with any pre-tax balances in all IRAs. Bypassing the traditional IRA and rolling over directly to a Roth IRA avoids that.
I don’t get your second paragraph. can you give an example.
We have to distinguish between the term "direct" with regards to the type of rollover and the destination. Direct rollovers from qualified plans to IRA accounts are always preferred. The rollovers themselves are not a problem, they are not subject to the one IRA rollover per twelve month period rule, but indirect rollovers (checks made out to you personally) of pre-tax amounts are subject to 20% withholding.

The most important point is that a single rollover of the (after-tax contributions + pre-tax earnings) or the after-tax contribution component of the split rollover should go directly to the Roth IRA without going through a traditional IRA and subsequent Roth conversion. The latter is unnecessary and counter-productive.

Employee after-tax contributions are always after-tax, but earnings on those contributions are always pre-tax. You must rollover both proportionally. This is usually accomplished by rolling over the entire account. When it is done by single rollover to a Roth IRA, the pre-tax earnings are taxable. When it is done by a split rollover with the employee after-tax contributions going to a Roth IRA and the pre-tax earnings to a traditional IRA, both rollovers are tax-free.

Although, you now have pre-tax IRA assets in the traditional IRA. If you are doing Backdoor Roths, you will want to roll that back into the plan if it allows it. If the plan doesn't, you would have been better off just rolling over both to a Roth iRA.

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Wed May 15, 2019 1:00 pm

Almond wrote:
Wed May 15, 2019 8:24 am
Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.
Are you asking about individual retirement account contributions or self-employed employer retirement plan contributions.

IRA contributions are based on compensation, For a self-employed individual, this is Form 1040, Schedule 1, Line 12 (business profit) - Line 27 (1/2 SE tax) - Line 28 (pre-tax employer retirement plan contributions)

Self-employed employer retirement plan contributions are based on self-employed earned income; Form 1040, Schedule 1, Line 12 (business profit) - Line 27 (1/2 SE tax)

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Wed May 15, 2019 1:03 pm

Greenman72 wrote:
Wed May 15, 2019 11:08 am
or a "shareholder's meeting" in Vegas or Orlando.
Aren't you a CPA. Come on, a shareholder's meeting for one shareholder???

Greenman72
Posts: 325
Joined: Fri Nov 01, 2013 2:17 pm

Re: Benefits of becoming an independent contractor

Post by Greenman72 » Wed May 15, 2019 2:29 pm

Spirit Rider wrote:
Wed May 15, 2019 1:03 pm
Greenman72 wrote:
Wed May 15, 2019 11:08 am
or a "shareholder's meeting" in Vegas or Orlando.
Aren't you a CPA. Come on, a shareholder's meeting for one shareholder???
Well, his wife could also be a shareholder.
I would probably allow this, depending on how much money they made and how much the shareholder's meeting cost. If you made $500,000 last year and you write off a $10,000 "shareholder's meeting", then I'd probably allow that. However, it would be limited to just the travel, hotel, and meals. Any "extras" such as Disneyworld tickets is a personal expense. And you need to actually keep minutes and send them to me as part of the documentation.

If the contractor made $15,000 and is trying to write off a $50,000 "shareholder's meeting", then I'll probably push back on it.

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Wed May 15, 2019 3:58 pm

Spirit Rider wrote:
Wed May 15, 2019 1:00 pm
Almond wrote:
Wed May 15, 2019 8:24 am
Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.
Are you asking about individual retirement account contributions or self-employed employer retirement plan contributions.

IRA contributions are based on compensation, For a self-employed individual, this is Form 1040, Schedule 1, Line 12 (business profit) - Line 27 (1/2 SE tax) - Line 28 (pre-tax employer retirement plan contributions)

Self-employed employer retirement plan contributions are based on self-employed earned income; Form 1040, Schedule 1, Line 12 (business profit) - Line 27 (1/2 SE tax)
I am basing it on self employed which I thought was net after deductions. In your 100k example above you based it on gross and took deductions for rent etc after.

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Wed May 15, 2019 4:08 pm

Spirit Rider wrote:
Wed May 15, 2019 12:19 pm
Almond wrote:
Wed May 15, 2019 8:11 am
Spirit Rider wrote:
Tue May 14, 2019 1:39 pm
The direct rollover of employee after-tax contributions and earnings to a Roth IRA, do not go through a traditional IRA, are not reported on Form 8606 and are not subject to any pro-rata taxation.

The pre-tax earnings are taxable when rolled over to a Roth IRA, but not when rolled over to a traditional IRA with a split rollover. Most plans that support employee after-tax contributions and in-service rollovers of such also accept IRA rollovers. You can then rollover the pre-tax assets in the traditional IRA back into the plan, preventing any future pro-rata taxation.
So if I understand anything rollover in after tax contributions are not pro-rate taxation. Are you saying money has to go direct to Roth IRA and can not be done via backdoor? I know direct Roth contributions are not prorated, but you seemed to suggest you can do indirect and then rollover and still not subject to pro-rate
It is not that the rollover has to go directly to a Roth IRA, just that it can. However, if you rollover the employee after-tax account to a traditional IRA and then do a Roth conversion. That Roth conversion is subject to pro-rata taxation with any pre-tax balances in all IRAs. Bypassing the traditional IRA and rolling over directly to a Roth IRA avoids that.
I don’t get your second paragraph. can you give an example.
We have to distinguish between the term "direct" with regards to the type of rollover and the destination. Direct rollovers from qualified plans to IRA accounts are always preferred. The rollovers themselves are not a problem, they are not subject to the one IRA rollover per twelve month period rule, but indirect rollovers (checks made out to you personally) of pre-tax amounts are subject to 20% withholding.

The most important point is that a single rollover of the (after-tax contributions + pre-tax earnings) or the after-tax contribution component of the split rollover should go directly to the Roth IRA without going through a traditional IRA and subsequent Roth conversion. The latter is unnecessary and counter-productive.

Employee after-tax contributions are always after-tax, but earnings on those contributions are always pre-tax. You must rollover both proportionally. This is usually accomplished by rolling over the entire account. When it is done by single rollover to a Roth IRA, the pre-tax earnings are taxable. When it is done by a split rollover with the employee after-tax contributions going to a Roth IRA and the pre-tax earnings to a traditional IRA, both rollovers are tax-free.

Although, you now have pre-tax IRA assets in the traditional IRA. If you are doing Backdoor Roths, you will want to roll that back into the plan if it allows it. If the plan doesn't, you would have been better off just rolling over both to a Roth iRA.
Hmm still not sure I understand. Self employed I currently have $200k in SEP IRA. This year I plan to max out my solo 401k getting the pre tax deductions. Now I want to use post tax dollars to fund a roth. If I am under the ROTH income limit, which I think I am, I can fund the Roth direct up to I am not sure how much. Is that what you are saying?

If I am over the income limit then I have to do a backdoor and then that becomes pro-rata based on my sep and solo 401k. Are you saying there is a way to do this and avoid that?

thank you

Spirit Rider
Posts: 10634
Joined: Fri Mar 02, 2007 2:39 pm

Re: Benefits of becoming an independent contractor

Post by Spirit Rider » Wed May 15, 2019 5:03 pm

I have done the best I can explaining the distinct differences. Someone else will have to try. I suggest contacting a professional.

Greenman72
Posts: 325
Joined: Fri Nov 01, 2013 2:17 pm

Re: Benefits of becoming an independent contractor

Post by Greenman72 » Wed May 15, 2019 7:44 pm

^Contacting a professional is against our religion. I hope you get banned for even suggesting it.

How dare you suggest that a totally clueless person actually.....*gasp*....pay for help!?!?!?

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Thu May 16, 2019 11:07 am

Spirit Rider wrote:
Wed May 15, 2019 5:03 pm
I have done the best I can explaining the distinct differences. Someone else will have to try. I suggest contacting a professional.
Thanks I appreciate you trying. Will google to see if I can get a better understanding. I am looking at how this work if you are self employed and already have a pre tax Ira. my understanding is if you rollover to a Roth it is taxable period.

If this year I fund to the max a pretax Ira and all fund a post tax Ira what are my Roth options and what are the tax implications.

fyre4ce
Posts: 218
Joined: Sun Aug 06, 2017 11:29 am

Re: Benefits of becoming an independent contractor

Post by fyre4ce » Thu May 16, 2019 8:04 pm

Almond wrote:
Wed May 15, 2019 8:24 am
fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.

Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.

Thank you
I will try to clarify as best I can.

First of all, let's make sure we distinguish between an IRA and a SEP-IRA. An IRA is available to all taxpayers earning money, is an individual account, and has a $6k or $7k annual limit. Can be Traditional or Roth, and Traditional contributions can be tax-deductible or not, based on your income.

Based on later posts I'm assuming you are talking about a SEP-IRA. A SEP-IRA is only available to the self-employed, but works if you're incorporated or
a sole proprietor. The contribution limit is $56,000 per year (as of 2019) and there are additional limits depending on whether you're a sole proprietor or incorporated. This limit is separate from any IRA limits.

Assuming you're a sole proprietor, you can only contribute 20% of your net business income (gross receipts minus deductions minus half of the self-employment tax). In my above example, gross receipts are $180,000, accounting and other deductions are $18,000, and you also have to subtract half of the FICA/self-employment taxes. Total FICA/self-employment taxes (both halves) of $162,000 are $16,479.60 ($132,900 * 12.4%) for Social Security and $4,338.60 ($162,000 *(1 - 7.65%) * 2.9%) Medicare, so $20,818.20 total. Half that is $10,409.10, so the maximum SEP-IRA contribution is $30,318.18 ([$180,000 - $18,000 - $10,409.10] * 20%).

Assuming you're incorporated, you can contribute 25% of wages. So in the breakdown I gave in my earlier post, with $100,000 declared wages, you can contribute $25,000 ($100,000 * 25%) to the SEP-IRA. Compared to a sole proprietor, this is a disadvantage, although you save payroll taxes due to the lower wages. If you wanted to raise the SEP-IRA contribution, you could raise wages.

Note that the 20% vs. 25% are actually mathematically equivalent. The 20% applies to the entire gross earnings, and the 25% is for when you're deducting the contribution.

Rules for a Solo 401k are different, and better. You can contribute $19,000 (as of 2019) as an "elective deferral", up to 100% of your income. The business can also make contributions on your behalf, up to the same $56,000 limit total for elective deferral and employer contribution. Rules for contributing the remainder also depend on whether you're a sole proprietor or incorporated.

If you're a sole proprietor, the calculation is the same above, except that the calculation is for the employer portion and is in addition to the elective deferral. So, you could contribute $19,000 elective deferral, plus $30,318.18 employer contributions, for a total of $49,318.18. That's more than with the SEP-IRA.

If you're incorporated, you pay the elective deferral out of the wages, and the maximum employer contribution is 25% of wages. That's where the $25,000 came from in my example. If you add in $19,000 elective deferral, that's $44,000 total. Again, raising wages will raise the total contribution. Wages needed to meet the $56k maximum are $148k.

One reason the Solo 401k is better is that you can contribute more. To reach the maximum SEP-IRA contribution you need net business income of about $290k, whereas you need only ~$190k to max out a Solo 401k. Below ~$290k the Solo 401k can take more.

Almond
Posts: 38
Joined: Wed May 01, 2019 3:11 pm

Re: Benefits of becoming an independent contractor

Post by Almond » Fri May 17, 2019 12:57 pm

fyre4ce wrote:
Thu May 16, 2019 8:04 pm
Almond wrote:
Wed May 15, 2019 8:24 am
fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.

Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.

Thank you
I will try to clarify as best I can.

First of all, let's make sure we distinguish between an IRA and a SEP-IRA. An IRA is available to all taxpayers earning money, is an individual account, and has a $6k or $7k annual limit. Can be Traditional or Roth, and Traditional contributions can be tax-deductible or not, based on your income.

Based on later posts I'm assuming you are talking about a SEP-IRA. A SEP-IRA is only available to the self-employed, but works if you're incorporated or
a sole proprietor. The contribution limit is $56,000 per year (as of 2019) and there are additional limits depending on whether you're a sole proprietor or incorporated. This limit is separate from any IRA limits.

Assuming you're a sole proprietor, you can only contribute 20% of your net business income (gross receipts minus deductions minus half of the self-employment tax). In my above example, gross receipts are $180,000, accounting and other deductions are $18,000, and you also have to subtract half of the FICA/self-employment taxes. Total FICA/self-employment taxes (both halves) of $162,000 are $16,479.60 ($132,900 * 12.4%) for Social Security and $4,338.60 ($162,000 *(1 - 7.65%) * 2.9%) Medicare, so $20,818.20 total. Half that is $10,409.10, so the maximum SEP-IRA contribution is $30,318.18 ([$180,000 - $18,000 - $10,409.10] * 20%).

Assuming you're incorporated, you can contribute 25% of wages. So in the breakdown I gave in my earlier post, with $100,000 declared wages, you can contribute $25,000 ($100,000 * 25%) to the SEP-IRA. Compared to a sole proprietor, this is a disadvantage, although you save payroll taxes due to the lower wages. If you wanted to raise the SEP-IRA contribution, you could raise wages.

Note that the 20% vs. 25% are actually mathematically equivalent. The 20% applies to the entire gross earnings, and the 25% is for when you're deducting the contribution.

Rules for a Solo 401k are different, and better. You can contribute $19,000 (as of 2019) as an "elective deferral", up to 100% of your income. The business can also make contributions on your behalf, up to the same $56,000 limit total for elective deferral and employer contribution. Rules for contributing the remainder also depend on whether you're a sole proprietor or incorporated.

If you're a sole proprietor, the calculation is the same above, except that the calculation is for the employer portion and is in addition to the elective deferral. So, you could contribute $19,000 elective deferral, plus $30,318.18 employer contributions, for a total of $49,318.18. That's more than with the SEP-IRA.

If you're incorporated, you pay the elective deferral out of the wages, and the maximum employer contribution is 25% of wages. That's where the $25,000 came from in my example. If you add in $19,000 elective deferral, that's $44,000 total. Again, raising wages will raise the total contribution. Wages needed to meet the $56k maximum are $148k.

One reason the Solo 401k is better is that you can contribute more. To reach the maximum SEP-IRA contribution you need net business income of about $290k, whereas you need only ~$190k to max out a Solo 401k. Below ~$290k the Solo 401k can take more.
Thank you that really helped and looks like solo 401k makes sense. With the solo from my reading it seems the employer contribution can be post tax money. Might make sense to do this so as to use the QBI deduction. With the post tax money want it to go into a Roth and tax deferred into a solo. Seems some use solo Roth plans administered by online business I think called or something, don’t have the name handy, is that the way to do it? Also can I set up the same plan for my non working spouse?

Thank you so much really helped.

fyre4ce
Posts: 218
Joined: Sun Aug 06, 2017 11:29 am

Re: Benefits of becoming an independent contractor

Post by fyre4ce » Fri May 17, 2019 2:20 pm

Almond wrote:
Fri May 17, 2019 12:57 pm

Thank you that really helped and looks like solo 401k makes sense. With the solo from my reading it seems the employer contribution can be post tax money. Might make sense to do this so as to use the QBI deduction. With the post tax money want it to go into a Roth and tax deferred into a solo. Seems some use solo Roth plans administered by online business I think called or something, don’t have the name handy, is that the way to do it? Also can I set up the same plan for my non working spouse?

Thank you so much really helped.
In the match-up between the Solo 401k and the SEP-IRA, the Solo 401k definitely wins. Biggest advantages of the Solo 401k are that you can contribute more if you earn less than ~$300k, and it doesn't interfere with doing Backdoor Roth IRA contributions like the SEP-IRA does. The SEP-IRA balance is taken into account in the pro-rata calculation on the Roth conversion step, but the 401k balance is not. Other smaller advantages for the Solo 401k are the ability to do Roth contributions for the employee elective deferral, and possibly doing 401k loans.

All SEP-IRA contributions have to be pre-tax, there's not Roth option. Likewise, for employer Solo 401k contributions. Employee 401k contributions can be pre-tax or Roth (legally, but the provider has to allow it and not all do). It's possible (legal) for a 401k provider to offer in-service Roth conversions, so if you really want to do Roth contributions, make an employer pre-tax contribution and then do an in-service Roth conversion. But make sure your provider will allow this before you set up your plan.

For a SEP-IRA, I believe it's possible to do in-service Roth IRA conversions, but again, if this is something you want, make sure you shop around and find a provider who allows this before you set the plan up.

If your spouse doesn't work, they cannot be added to your solo 401k or SEP-IRA. Both of those accounts are necessarily one-participant. You could pay your spouse on a 1099 and have them become an independent contractor to your business and open their own Solo 401k, but there are two problems with this. First, in order to be legal, you have to be paying them a fair wage for the work they do. You can't pay your spouse $200,000 per year to clean your office every couple weeks. If the IRS catches you doing something like this, they'll hit you with back taxes, interest, and penalties. On the other hand, if your spouse is actually doing real work for your business - answering the phone, paperwork, accounting, taxes, etc, then it's fair to pay them a salary, but it has to be reasonable for the work they do. Second, if you hire your spouse, they have to pay payroll tax, which can be up to 16.2%. Usually this doesn't make sense for this reason. I don't have any experience hiring a spouse so if you are really interested I suggest you do your own research into how best to structure it. If trying to save more tax-advantaged than the $56k limit plus personal and spousal Backdoor Roth IRAs can accommodate, you can also look into Defined Benefit Plans. They have more fees than a Solo 401k, but the fees might be lower than payroll taxes on wages.

Edit: I've seen some websites today that say that spouses CAN be added to Solo 401k's. This is news to me. However, it still doesn't solve the payroll tax issue and the reasonable compensation issue.

Topic Author
cbr shadow
Posts: 257
Joined: Wed Jul 10, 2013 2:12 pm

Re: Benefits of becoming an independent contractor

Post by cbr shadow » Thu Jun 13, 2019 6:17 pm

Almond wrote:
Fri May 17, 2019 12:57 pm
fyre4ce wrote:
Thu May 16, 2019 8:04 pm
Almond wrote:
Wed May 15, 2019 8:24 am
fyre4ce wrote:
Mon May 13, 2019 6:00 pm
If you gross $180k as an independent contractor, you won't be able to, nor will you want to, have a salary of $180k. Let's say your salary is $100k. Your business account would look something like this:

Salary: $100k
Employer 401k: $25k (25% of salary up to $56k total employer + employee)
Employer half of FICA: $7.65k
Accounting and payroll expenses: $3k
Miscellaneous deductions: $15k (home office, mileage, etc)
Net Business Profit: $29,350 (probably deductible as Section 199A QBI)

Higher salary lets you put more into the 401k, up to $148k (($56k - $19k) / 25%), as long as you have enough business income to pay the salary, put away the savings, pay all the taxes and take all the deductions you want, and still have the business be net positive for the year. You can't run the business at a loss.

On the other hand, lower salary saves FICA (at a high rate if you're below $132,900) and also lets you take a higher QBI, which might be deductible on your Form 1040. You'll have to run the numbers and see what is the overall best combination for you. Also make sure your salary is "reasonable" per IRS rules.

In general I like the independent contractor structure much better than W-2. If you know the tax code well, you can probably find some legal deductions you can take that you can't as a W-2. You also get the possibility of QBI deduction. But you should look a the deductions you can legally take and run the numbers both ways.

Quick question. I thought the amount you can contribute to IRA is based on net income, after deductions. You seem to be basing it on gross. I am trying to help my partner figure out how much she can contribute going forward. be great if it is based on gross before deductions.

Thank you
I will try to clarify as best I can.

First of all, let's make sure we distinguish between an IRA and a SEP-IRA. An IRA is available to all taxpayers earning money, is an individual account, and has a $6k or $7k annual limit. Can be Traditional or Roth, and Traditional contributions can be tax-deductible or not, based on your income.

Based on later posts I'm assuming you are talking about a SEP-IRA. A SEP-IRA is only available to the self-employed, but works if you're incorporated or
a sole proprietor. The contribution limit is $56,000 per year (as of 2019) and there are additional limits depending on whether you're a sole proprietor or incorporated. This limit is separate from any IRA limits.

Assuming you're a sole proprietor, you can only contribute 20% of your net business income (gross receipts minus deductions minus half of the self-employment tax). In my above example, gross receipts are $180,000, accounting and other deductions are $18,000, and you also have to subtract half of the FICA/self-employment taxes. Total FICA/self-employment taxes (both halves) of $162,000 are $16,479.60 ($132,900 * 12.4%) for Social Security and $4,338.60 ($162,000 *(1 - 7.65%) * 2.9%) Medicare, so $20,818.20 total. Half that is $10,409.10, so the maximum SEP-IRA contribution is $30,318.18 ([$180,000 - $18,000 - $10,409.10] * 20%).

Assuming you're incorporated, you can contribute 25% of wages. So in the breakdown I gave in my earlier post, with $100,000 declared wages, you can contribute $25,000 ($100,000 * 25%) to the SEP-IRA. Compared to a sole proprietor, this is a disadvantage, although you save payroll taxes due to the lower wages. If you wanted to raise the SEP-IRA contribution, you could raise wages.

Note that the 20% vs. 25% are actually mathematically equivalent. The 20% applies to the entire gross earnings, and the 25% is for when you're deducting the contribution.

Rules for a Solo 401k are different, and better. You can contribute $19,000 (as of 2019) as an "elective deferral", up to 100% of your income. The business can also make contributions on your behalf, up to the same $56,000 limit total for elective deferral and employer contribution. Rules for contributing the remainder also depend on whether you're a sole proprietor or incorporated.

If you're a sole proprietor, the calculation is the same above, except that the calculation is for the employer portion and is in addition to the elective deferral. So, you could contribute $19,000 elective deferral, plus $30,318.18 employer contributions, for a total of $49,318.18. That's more than with the SEP-IRA.

If you're incorporated, you pay the elective deferral out of the wages, and the maximum employer contribution is 25% of wages. That's where the $25,000 came from in my example. If you add in $19,000 elective deferral, that's $44,000 total. Again, raising wages will raise the total contribution. Wages needed to meet the $56k maximum are $148k.

One reason the Solo 401k is better is that you can contribute more. To reach the maximum SEP-IRA contribution you need net business income of about $290k, whereas you need only ~$190k to max out a Solo 401k. Below ~$290k the Solo 401k can take more.
Thank you that really helped and looks like solo 401k makes sense. With the solo from my reading it seems the employer contribution can be post tax money. Might make sense to do this so as to use the QBI deduction. With the post tax money want it to go into a Roth and tax deferred into a solo. Seems some use solo Roth plans administered by online business I think called or something, don’t have the name handy, is that the way to do it? Also can I set up the same plan for my non working spouse?

Thank you so much really helped.
oh wow. You very much took over my thread! ha! Why not just post a new topic w/ a unique question? I'd like to circle back to expand on my topic and get more feedback but your topic right in the middle of the thread lowers the likelyhood of someone reading through everything (my topic, then yours, then back to mine).

ralph124cf
Posts: 2242
Joined: Tue Apr 01, 2014 11:41 am

Re: Benefits of becoming an independent contractor

Post by ralph124cf » Fri Jun 14, 2019 12:50 pm

You have mentioned that you live in California. California is a real pain for small incorporated businesses. For that reason only I would choose to be a sole proprietor.

Ralph

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