FICA TAX Question (EMPLOYEE and EMPLOYER/EMPLOYEE SIDE BUSINESS)

16 Replies

I'm hoping a tax expert can answer this question I have. 

In my current job, I make close to the fica cap which my employer pays both employer and my portion as the employee. I only contribute the matching 5% to my 401k which is around $6,645.00 bc it's a guaranteed 100% return. My reasons for not wanting to invest any more than the matching is due to the very limited control i have.

I want to open a side business due to the extra income I am already making. From my research so far, I've determined an LLC taxed as an s corp appears to be the best option. I also want a Solo 401k and plan to pay myself $150,000 so that I contribute 25% of my salary as the employer which is $37,500. Then I'd like to make the rest of my own contribution as employee of ($19,500-$6645) = $12,855 to equal the maximum allowable of $57,000 (37500+12855+6645) If this is how this works...I'm assuming 57k is max across everything...

My question is, since my main job has already payed both the employer and employee portion of the social security tax, will I only have to pay medicare taxes on my 2nd business? The potential tax savings I'm calculating after solo 401k deductions appears to be enormous versus not opening the business at all and I can't help but wonder if I am missing something? Are my assumptions correct on the solo 401k how everything is calculated? Thank you

Zach

@Zach P.

While I’m not a tax professional, I’d like to think i know something about this....

First, is your side business income active or passive? There is nothing to tell what sort of investing you are doing. If they are rentals the income is going to be passive. If so, you plan is a bit screwy since passive income is generally considered more advantageously taxed than active. Assuming you can get your passive income into the S Corp to pay you the salary, it’s a personal decision if it’s worth paying your marginal tax rate so that you can sock money away into a solo 401k...

For a single self employed solo 401k, you do the full $59k (whatever the current limit is), but the employer contribution side is more like 20% (honestly, not sure if applicable for S Corp status). It’s a little wacky and the irs has a table you use to calc because there is a circular equation generated by the se tax deduction. That being said, not sure how that works with you since you are maxed out by your w2 income

Anyway, yes you wont be saving the fica taxes since you are maxed. Also, why not just a plain LLC? You still have the option to pay yourself a salary. It's just the S Corp requires you pay owners/shareholders who materially participate a reasonable salary. Save yourself the extra costs of doing the related tax forms and stuff for the S Corp

Here’s another one: depending on the nature of the income of your side business, I think you can still have the solo 401k as a sole proprietor. So just just do whatever your State/municipality requires to register a sole proprietor, file for the EIN, then you should be able to get your solo 401k.

Make any sense? It’s a little tough since I don’t know the nature of the income for this side business of yours. Good luck

Hi David, thank you for your reply.

The income I have made is trader income. According to the research I have done so far, trader income is not considered "earned income". From what I have read, unless I pay myself a salary from my trader income, I cannot use the llc's income to contribute to a solo 401k. I believe the 20% you are referring to is based off of the llc's net income if I didn't pay myself. But that's the problem, is that it's not earned income. What I am hoping is that the only taxes I will have to pay even when paying myself, will be 2.9% total just for the medicare based on my original post since i already hit the fica cap from my main job. Using a traditional solo 401k ira, then i would be able to reduce my taxable income by $50,000. I hope my thinking isn't messed up on this. Thanks.

@Zach P.

I don't understand your dilemma of "versus not opening the business at all" while you also claim "the extra income I am already making." If you are already making income, you already have a business, most likely. Are you thinking that you must form an LLC in order to have a business? If this is your thinking, you're wrong. A business exists with or without an LLC, and such business can establish a retirement plan, including a solo 401k.

Your $57k solo 401k limit is not reduced by your 401k contribution at work. So you get $57k + $6,645.

S-corp in your situation can be counter-productive. You will have to pay employer's portion of Soc Security even though you maxed out on the employee's side.

All of that really requires a more holistic review from a good tax accountant or a good financial planner. Or both.



Thanks for the reply Michael. Im definitely more confused now though. This is from bigger pockets.    V  V

Who is qualified for a Solo 401k

Only businesses that can provide wages and earned income to the owner can qualify for a Solo 401k plan.

According to everything ive read, trader income which is what all my extra income is, is not earned income. Can you explain what i am not understanding? 

Hey Zach,

I'm not your tax guy so hire one. And, I don't practice, but I know a little bit about taxes. Good that you accounted for the employee max deferral across plans i.e. $19,500.

You will likely have to pay both the Social Security portion and the Medicare portion on your self-employment salary. It's true that SS caps out once your income reaches a certain threshold, but you'll withhold as though you're starting from zero with a new job, i.e. your side biz. Any overage in SS tax will be credited to you later on. Also worth noting that if you check the box to be taxed as an s-corp, you have to pay yourself a reasonable salary and there are fuzzy guidelines on what that means. Is $150k reasonable for what you'll be doing? Could you pay yourself less and take the remainder as K-1 distributions? That would save you a bit of Medicare tax. Good luck and talk to someone qualified before forming your LLC and retirement plan.

Disagree regarding aggregation and control rules comments above. Your annual employee contributions across 401(k) plans cannot exceed $19,500 plus applicable catch-up contributions (excluding After-Tax/MegaRoth which you aren't asking about). I don't believe you would be able to contribute $57,000+$6,645. You'd be looking at excise tax, penalties and headaches. You might be fine if maxing a 401(k) and SEP IRA held through unrelated employers. Again, consult with a qualified tax pro.

Originally posted by @Zach P. :

Thanks for the reply Michael. Im definitely more confused now though. According to everything ive read, trader income which is what all my extra income is, is not earned income. Can you explain what i am not understanding? 

I don't think you mentioned that it was trader income until after I responded. You called it business, so my assumption was that it was business, like consulting or selling stuff. Normally, trader income is not earned income. You cannot pay salary off of it or create retirement plans. 

Sometimes, however, if your trading activity is substantial enough, it can rise to the level of "trade or business" which has both positives and negatives. This is complex and not something to settle in an online post. $150k income warrants paying a good accountant to analyze its tax attributes.

@Zach P.

I agree with  @Michael Plaks ( of course) that you should consult a professional, or two.  Trader income (which I assume to mean stocks and bonds or the like) isn't earned/active income that you can put into the solo 401k.  How you get that to be a "trade or business" is definitely something you need to figure out, but not here on a public forum.

Also, honestly I thought the $57k was aggregate.  For example, if you had two jobs that gave you a 401k benefit, between the both you couldn't exceed the $19k employee contribution.  That's just the employee side.

It is interesting since assuming if you could pay yourself a salary, you wouldn't be paying additional FICA since you'd be maxed out by your day job (as long as you don't get fired or leave you wouldn't have to worry about the estimated tax for the FICA, in my opinion, since you know you will be covered).  At least short term capital gains are taxed at your marginal rate so you aren't "losing" anything there.  So maybe just pay yourself a salary from your short term gains portion...  So, maybe you could put a chunk away into a tax advantaged account.

Again, interesting to think about, but you need some dedicated assistance.  Good luck.

@Zach P.

There is a more than a little bit of incorrect information in this thread...  Let's un-muddy the waters...

First, income from trading, like investment income, is not earned income for retirement account purposes.  This is true even if you (or a controlled entity) make a Sec 475(f) election.  For this reason, many self-employed, tax status traders do their trading through a wholly-owned corporate tax entity, either S or C (usually S), to open up retirement and health insurance planning opportunities.

Second, you should talk to your tax professional about a Sec 475(f) election, and the interplay with the QBI deduction thereunder, taking into consideration Specified Service Business Treatment and phase-out limitations.  A planning engagement with a projection might be in order.

Third, there are a few different limitations on qualified retirement plan contributions. First, elective deferrals are aggregated across all 401(k) plans (the Sec 402(g) limit). So, if you contribute $6,645 for the 2020 tax year to a non-equity W-2, you would be able to concurrently contribute up to $12,855 through a Solo 401(k). Second, the "overall" limit does NOT aggregate across all 401(k) plans unless we have common control (the Sec 402(c) limit). Your non-equity employer's 401(k) plan and a Solo 401(k) would NOT be aggregated under Sec 402(c). Therefore, you could contribute up to $57k at the non-equity W-2 (allowable employee deferral plus employer match) AND up to $57k in your Solo 401(k) (allowable employee deferral plus employer contribution). Of course, contributions will be limited by earned income.

Your tax situation is complex enough to warrant onboarding a tax professional as a permanent external partner on your team.

Originally posted by @Joseph Mah :

Disagree regarding aggregation and control rules comments above. Your annual employee contributions across 401(k) plans cannot exceed $19,500 plus applicable catch-up contributions (excluding After-Tax/MegaRoth which you aren't asking about). I don't believe you would be able to contribute $57,000+$6,645. You'd be looking at excise tax, penalties and headaches. You might be fine if maxing a 401(k) and SEP IRA held through unrelated employers. Again, consult with a qualified tax pro.

It is possible that I'm wrong, and I do not have time right now to verify which one of us is correct.

Here's my reasoning that does not actually contradict yours. Yes, elective deferrals are aggregated. However, we can limit elective deferrals to $6,645 in his case. Ignoring the issue of trader income not being eligible, the entire $57,000 Solo 401k contribution could be structured as employer's contribution (with compensation high enough) without employee deferral component.




























 

Originally posted by @Joseph Mah :

Hey Zach,

I'm not your tax guy so hire one. And, I don't practice, but I know a little bit about taxes. Good that you accounted for the employee max deferral across plans i.e. $19,500.

You will likely have to pay both the Social Security portion and the Medicare portion on your self-employment salary. It's true that SS caps out once your income reaches a certain threshold, but you'll withhold as though you're starting from zero with a new job, i.e. your side biz. Any overage in SS tax will be credited to you later on. Also worth noting that if you check the box to be taxed as an s-corp, you have to pay yourself a reasonable salary and there are fuzzy guidelines on what that means. Is $150k reasonable for what you'll be doing? Could you pay yourself less and take the remainder as K-1 distributions? That would save you a bit of Medicare tax. Good luck and talk to someone qualified before forming your LLC and retirement plan.

I'd rather pay myself less if the distributions could still be used as a basis for solo 401k contributions. Or maybe pay myself a small salary and a bonus based on how well I do if this is allowed. Thanks Joseph

 

Originally posted by @Michael Plaks :
Originally posted by @Zach P.:

Thanks for the reply Michael. Im definitely more confused now though. According to everything ive read, trader income which is what all my extra income is, is not earned income. Can you explain what i am not understanding? 

I don't think you mentioned that it was trader income until after I responded. You called it business, so my assumption was that it was business, like consulting or selling stuff. Normally, trader income is not earned income. You cannot pay salary off of it or create retirement plans. 

Sometimes, however, if your trading activity is substantial enough, it can rise to the level of "trade or business" which has both positives and negatives. This is complex and not something to settle in an online post. $150k income warrants paying a good accountant to analyze its tax attributes.

Thank you Michael. I'm looking into it now. Have one appt scheduled in person this week. 

 

Originally posted by @Eamonn McElroy :

@Zach P.

There is a more than a little bit of incorrect information in this thread...  Let's un-muddy the waters...

First, income from trading, like investment income, is not earned income for retirement account purposes.  This is true even if you (or a controlled entity) make a Sec 475(f) election.  For this reason, many self-employed, tax status traders do their trading through a wholly-owned corporate tax entity, either S or C (usually S), to open up retirement and health insurance planning opportunities.

Second, you should talk to your tax professional about a Sec 475(f) election, and the interplay with the QBI deduction thereunder, taking into consideration Specified Service Business Treatment and phase-out limitations.  A planning engagement with a projection might be in order.

Third, there are a few different limitations on qualified retirement plan contributions.  First, elective deferrals are aggregated across all 401(k) plans (the Sec 402(g) limit).  So, if you contribute $6,645 for the 2020 tax year to a non-equity W-2, you would be able to concurrently contribute up to $12,855 through a Solo 401(k).  Second, the "overall" limit does NOT aggregate across all 401(k) plans unless we have common control (the Sec 402(c) limit).  Your non-equity employer's 401(k) plan and a Solo 401(k) would NOT be aggregated under Sec 402(c).  Therefore, you could contribute up to $57k at the non-equity W-2 (allowable employee deferral plus employer match) AND up to $57k in your Solo 401(k) (allowable employee deferral plus employer contribution).  Of course, contributions will be limited by earned income.

Your tax situation is complex enough to warrant onboarding a tax professional as a permanent external partner on your team.

 That would be outstanding! As much as I try to figure out everything myself, I am finding the amount of knowledge from being a CPA and entity expert to be more than I may be able to learn without going to school.  I appreciate yours and everyone elses advice on my question. Meeting scheduled...

Originally posted by @David M. :

@Zach P.

I agree with  @Michael Plaks ( of course) that you should consult a professional, or two.  Trader income (which I assume to mean stocks and bonds or the like) isn't earned/active income that you can put into the solo 401k.  How you get that to be a "trade or business" is definitely something you need to figure out, but not here on a public forum.

Also, honestly I thought the $57k was aggregate.  For example, if you had two jobs that gave you a 401k benefit, between the both you couldn't exceed the $19k employee contribution.  That's just the employee side.

It is interesting since assuming if you could pay yourself a salary, you wouldn't be paying additional FICA since you'd be maxed out by your day job (as long as you don't get fired or leave you wouldn't have to worry about the estimated tax for the FICA, in my opinion, since you know you will be covered).  At least short term capital gains are taxed at your marginal rate so you aren't "losing" anything there.  So maybe just pay yourself a salary from your short term gains portion...  So, maybe you could put a chunk away into a tax advantaged account.

Again, interesting to think about, but you need some dedicated assistance.  Good luck.

 Great idea. And I'm discovering I need to keep my long term investments in a separate account and also to try not to trade the same stocks in retirement accounts.  The government really doesn't make this easy....Thanks David