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Hot Topics: Tax Savings Tips

Breaking News: New PPP for the Self-Employed and Small Businesses

Two big deals.

Big Deal 1

To reserve Paycheck Protection Program (PPP) monies for you, the Small Business Administration (SBA) established a 14-day exclusive application period for small businesses with fewer than 20 employees.

The window closes on March 9 at 5:00 p.m. Eastern time, so if you are an S or C corporation with fewer than 20 employees, apply for your first, second, or upgrade PPP money now.

Also, don’t apply just to your bank. You may find your bank useless, but start there anyway. And then apply to one of the online referrals such as Nav or Lendio, with which we and other members (subscribers) have had success. Take the money from the first lender willing to give it to you. Forget the laggards.

Big Deal 2

The SBA has created a new method and a new application for the Schedule C business that uses gross income rather than net profit to determine the money amount of the PPP. Using gross income rather than net income is a big deal for most Schedule C businesses as you can see in the following example.

Example. Sue is self-employed with no employees. Her gross income on line 7 of her Schedule C is $130,000. Her net income on line 31 is $72,000.
With the old method, she would have received approval for $15,000 of tax-free money ($72,000 ÷ 12 x 2.5).

With the new form available now, Sue uses the lesser of her gross income of $130,000 or the ceiling of $100,000 for the PPP application. She will receive $20,833 in tax-free money ($100,000 ÷ 12 x 2.5).

The new form gives Sue an extra $5,833 in tax-free money ($20,833 – $15,000).

The gross income method applies to new first-time and second-draw loans. Loans already approved may not be changed.

SEP IRA vs Solo 401(k): Which Should You Choose?

How do you multiply your net worth? Let the government help.

Here’s how: with both the SEP IRA and the solo 401(k) retirement plans, your investment in your tax-favored retirement

  • creates tax deductions for the money you invest in the plan,

  • grows tax-deferred inside the plan, and

  • suffers taxes only when you take the money from the plan.

Example. You invest $1,000 a month in your retirement. You are in the 40 percent tax bracket (combinedfederal and state), and you earn 10 percent on your investments. At the end of 30 years, you have $1.58 million in after-tax spendable cash, which comes from (in round numbers):

  • $1.2 million in after-tax cash from the retirement plan ($2 million gross less 40 percent in taxes—we’re taking the entire amount out of the plan in this example)

  • $380,000 in the side fund (created by investing the $400 of monthly tax savings—$1,000deduction x 40 percent)

If you had no government help on the taxes and invested $1,000 a month in an investment that earned 10percent (6 percent after taxes), you would have a little more than $950,000.

Winner. The retirement plan wins by $630,000—after taxes ($1.58 million vs $950,000).

Okay, that’s the big picture. It tells you that tax-advantaged investing multiplies profits. So, do it.

Which Plan Is Best for You?

When it comes to picking a retirement plan, you have many choices. If you have no employees in yourbusiness, none of the choices are bad. Let’s start there and say you have no employees. And let’s say further that you are going to choose between the SEP IRA and the solo 401(k).

Planning point. As a one-person business, you can operate as a C or S corporation, single member-LLC, orproprietorship and have either the SEP IRA or the solo 401(k).

Ease of Setup

The SEP IRA option is easier to set up—but there’s no rocket science required to establish a 401(k) plan.

You do have to pay attention to the solo 401(k) requirements, as they can change, but in general, your trusteeis going to help you stay in compliance.

Form 5500

But one filing requirement you need to pay attention to is that once your 401(k) account reaches $250,000 inassets, you must file Form 5500 with the IRS each year. And your trustee likely does not do this for you.Further, you may not have engaged your tax preparer to help with this.

Beginning with tax years 2020 and later, the IRS has made the Form 5500 EZ mandatory for use by the solo401(k) with $250,000 or more in assets, and it’s available for either online or paper filing.

The SEP rules do not require you to file Form 5500.

Why Choose a Solo 401(k)?

There are reasons to choose a solo 401(k). For one, if your goal is to stash away as much cash as possible,then a solo 401(k) may be an option worth looking into—especially if your income is on the smaller side.

With a solo 401(k), annual deductible contributions to the business owner’s account can come from twosources.

Source 1 (You): Elective Deferral Contributions

For 2021, you can contribute to your solo 401(k) account up to $19,500 ($26,000 if age 50 or older) of

  • your W-2 income if you are employed by your own C or S corporation, or

  • your net self-employment income if you operate as a sole proprietor or as a single-member LLCthat’s treated as a sole proprietorship for tax purposes.

Source 2 (Your Business): Employer Contributions

On top of your elective deferral contribution, the solo 401(k) arrangement permits an additional employercontribution of up to 25 percent of your corporate salary or 20 percent of your net self-employment income.

For purposes of calculating the employer contribution, your compensation or net self-employment income isnot reduced by your elective deferral contribution.

  • With a corporate plan, your corporation makes the employer contribution on your behalf.

  • With a plan set up for a sole proprietorship or a single-member LLC, you are effectively treatedas your own employer. Therefore, you make the employer contribution on your own behalf.

Strange, But True

Note that the one-person business is both an employee and an employer for the solo 401(k).

SEP IRA Has One Leg

With the SEP, you look at the employer contribution only—which is up to 25 percent of your W-2 wages if youoperate as a corporation or 20 percent of your self-employment income, as adjusted.

Comparison Example

Brayden Stout earns $19,000 from freelance work performed as an independent contractor.

  • Under the solo 401(k) rules, Brayden could contribute almost all of this $19,000 in net earningsto a solo 401(k).

  • Under the SEP IRA rules, he could contribute only about $3,800 ($19,000 x 20%).

High Income

If you are under age 50 and your income is on the higher side, the 2021 ceiling on contributions is $58,000.

But if you are age 50 or older, the solo 401(k) has a catch-up provision that allows you to contribute another $6,500, creating a maximum 2021 potential of $64,500.

The SEP IRA does not allow a catch-up contribution.

Planning point. The 401(k) catch-up contribution must come from an employee deferral.

Example. Sam Jones, age 53, operates a very profitable C corporation that pays him a big W-2 wage. The Ccorporation contributes $58,000 to Sam’s 401(k). That’s the employer’s maximum—the lesser of $58,000 or 25percent of Sam’s W-2 wages. Sam may make an employee elective deferral of $6,500 that reduces his taxableincome for the year and adds to his retirement fund, making $64,500 ($58,000 + $6,500) the total contributionsto his solo 401(k) for the year.

Key Comparison

The SEP IRA contribution can be made only by the employer—employee contributions are not allowed! Thesolo 401(k) plan allows both employer and employee contributions.

Example. Rose Rice, a self-employed engineer under the age of 50 has an annual profit of $120,000.

  • With the SEP IRA, Rose can contribute a maximum of $22,304.

  • With the solo 401(k), Rose can contribute a maximum of $41,804 ($19,500 as an employee and$22,304 as the employer).

Takeaways

The key to big retirement plan savings is to start early and invest well. And of course, the more money you can invest well, the more your retirement nest egg grows.

You have several retirement plan options. In this article, we made a comparison for the business owner with noemployees other than him or herself (if incorporated) and the SEP IRA with the solo 401(k) and offered thefollowing insights:

  • A SEP IRA is typically easier and cheaper to set up than a solo 401(k).

  • With the solo 401(k), you have to file form 5500EZ once your plan assets exceed $250,000.

  • In most cases, the owner of a one-person business can sock away more money for retirement with the solo 401(k) than with the SEP IRA because the solo 401(k) allows both the employeeelective deferral and the employer contribution.

Secrets to IRS Penalty Forgiveness Using Reasonable Cause


Uh-oh! In your mailbox, you found that dreaded envelope—the one from the IRS.

Inside the envelope, you find a notice from the IRS informing you that it assessed additional tax, penalties, and interest on your tax return from two years ago!

After you recover from the shock, you review your tax records for that year and realize to your dismay that the IRS is right: you do owe the additional tax.

The additional tax liability is bad enough, but the added penalties and interest are extra sources of aggravation. Is there any way for you to avoid paying them?

The tax code requires the IRS to charge interest on unpaid taxes and penalties. The IRS can waive interest only if

  • it made an administrative error; or

  • it caused an unnecessary delay in assessing the tax obligation.

On the other hand, the IRS can waive penalties it assessed against you or your business if there was “reasonable cause”3 for your actions.

Okay, we know what you’re thinking. This should not be too hard. After all, you understand the term “reasonable cause” and often use it in your everyday conversations!

Warning! Contrary to what you might think, the term “reasonable cause” is actually a term of art at the IRS. This seemingly simple phrase has a precise and detailed definition as it relates to penalty abatement.

Moreover, many of the rules and requirements for reasonable cause exceptions to penalties are downright tricky to navigate.