Do you own a successful small business with no employees and want to set up a retirement plan? Or do you want to upgrade from a SIMPLE IRA or Simplified Employee Pension (SEP) plan? Consider a solo 401(k) if you have healthy self-employment income and want to contribute substantial amounts to a retirement nest egg.

This strategy is geared toward self-employed individuals including sole proprietors, owners of single-member limited liability companies and other one-person businesses.

Go it alone

With a solo 401(k) plan, you can potentially make large annual deductible contributions to a retirement account.

For 2022, you can make an “elective deferral contribution” of up to $20,500 of your net self-employment (SE) income to a solo 401(k). The elective deferral contribution limit increases to $27,000 if you’ll be 50 or older as of December 31, 2022. The larger $27,000 figure includes an extra $6,500 catch-up contribution that’s allowed for these older owners.

On top of your elective deferral contribution, an additional contribution of up to 20% of your net SE income is permitted for solo 401(k)s. This is called an “employer contribution,” though there’s technically no employer when you’re self-employed. (The amount for employees is 25%.) For purposes of calculating the employer contribution, your net SE income isn’t reduced by your elective deferral contribution.

For the 2022 tax year, the combined elective deferral and employer contributions can’t exceed:

• $61,000 ($67,500 if you’ll be 50 or older as of December 31, 2022), or
• 100% of your net SE income.

Net SE income equals the net profit shown on Form 1040 Schedule C, E or F for the business minus the deduction for 50% of self-employment tax attributable to the business.

Pros and cons

Besides the ability to make large deductible contributions, another solo 401(k) advantage is that contributions are discretionary. If cash is tight, you can contribute a small amount or nothing.

In addition, you can borrow from your solo 401(k) account, assuming the plan document permits it. The maximum loan amount is 50% of the account balance or $50,000, whichever is less. Some other plan options, including SEPs, don’t allow loans.

The biggest downside to solo 401(k)s is their administrative complexity. Significant upfront paperwork and some ongoing administrative efforts are required, including adopting a written plan document and arranging how and when elective deferral contributions will be collected and paid into the owner’s account. Also, once your account balance exceeds $250,000, you must file Form 5500-EZ with the IRS annually.

If your business has one or more employees, you can’t have a solo 401(k). Instead, you must have a multi-participant 401(k) with all the resulting complications. The tax rules may require you to make contributions for those employees. However, there’s an important loophole: You can exclude employees who are under 21 and employees who haven’t worked at least 1,000 hours during any 12-month period from 401(k) plan coverage.

Bottom line: For a one-person business, a solo 401(k) can be a smart retirement plan choice if:

• You want to make large annual deductible contributions and have the money,
• You have substantial net SE income, and
• You’re 50 or older and can take advantage of the extra catch-up contribution.

Before you establish a solo 401(k), weigh the pros and cons of other retirement plans — especially if you’re 50 or older. Solo 401(k)s aren’t simple but they can allow you to make substantial and deductible contributions to a retirement nest egg. Contact us before signing up to determine what’s best for your situation.

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If you don’t have enough federal tax withheld from your paychecks and other payments, you may have to make estimated tax payments. This is the case if you receive interest, dividends, self-employment income, capital gains or other income. Here are the applicable rules for paying estimated tax without triggering the penalty for underpayment.

When are the payments due?

Individuals must pay 25% of a “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due on the next business day.

So the third installment for 2022 is due on Wednesday, September 15. Payments are made using Form 1040-ES.

How much should you pay?

The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 ($75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employers from their paychecks. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, divide that number by four and make four equal payments by the due dates.

But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow isn’t uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business operated in a resort area during June, July, and August, no estimated payment is required before September 15.

Who owes the penalty for underpaying?

If you don’t make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by the IRS on deficiencies, times the amount of the underpayment for the period of the underpayment.

However, the underpayment penalty doesn’t apply to you if:

• The total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
• You had no tax liability for the preceding year, you were a U.S. citizen or resident for that entire year, and that year was 12 months;
• For the fourth (January 15) installment, you file your return by that January 31 and pay your tax in full; or
• You are a farmer or fisherman and pay your entire estimated tax by January 15, or pay your entire estimated tax and file your tax return by March 1.

In addition, the IRS may waive the penalty if the failure was due to casualty, disaster or other unusual circumstances and it would be inequitable to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (and reach age 62) or become disabled.

Do you have more questions?

Contact us if you think you may be eligible to determine your estimated tax payments under the annualized income method, or you have other questions about how the estimated tax rules apply to you.

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When you filed your federal tax return this year, were you surprised to find you owed money? You might want to change your withholding so that this doesn’t happen again next year. You might even want to adjust your withholding if you got a big refund. Receiving a tax refund essentially means you’re giving the government an interest-free loan.

Adjust if necessary

Taxpayers should periodically review their tax situations and adjust withholding, if appropriate.

The IRS has a withholding calculator to assist you in conducting a paycheck checkup. The calculator reflects tax law changes in areas such as available itemized deductions, the child credit, the dependent credit and the repeal of dependent exemptions. You can access the IRS calculator here: https://www.irs.gov/individuals/tax-withholding-estimator

Life changes

There are some situations when you should check your withholding. In addition to tax law changes, the IRS recommends that you perform a checkup if you:

• Adjusted your withholding last year, especially in the middle or later part of the year,
• Owed additional tax when you filed your 2021 return,
• Received a refund that was smaller or larger than expected,
• Got married or divorced,
• Had a child or adopted one,
• Purchased a home, or
• Had changes in income.

You can modify your withholding at any time during the year, or even multiple times within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically go into effect several weeks after a new Form W-4 is submitted. (For estimated tax payments, you can make adjustments each time quarterly estimated payments are due. The next payments for 2022 are due on September 15, 2022, and January 16, 2023.)

Plan ahead now

There’s still time to remedy any shortfalls to minimize taxes due for 2022, as well as any penalties and interest. Contact us if you have any questions or need assistance. We can help you determine if you need to adjust your withholding.

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Sometimes, bigger isn’t better: Your small- or medium-sized business may be eligible for some tax breaks that aren’t available to larger businesses. Here are some examples.

1. QBI deduction

For 2018 through 2025, the qualified business income (QBI) deduction is available to eligible individuals, trusts and estates. But it’s not available to C corporations or their shareholders.

The QBI deduction can be up to 20% of:

• QBI earned from a sole proprietorship or single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
• QBI passed through from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes or S corporation.

Pass-through business entities report tax items to their owners, who then take them into account on their owner-level returns. The QBI deduction rules are complicated, and the deduction can be phased out at higher income levels.

2. Eligibility for cash-method accounting

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Under the cash method, you generally don’t have to recognize taxable income until you’re paid in cash. And you can generally write off deductible expenses when you pay them in cash or with a credit card.

Only “small” businesses are potentially eligible for the cash method. For this purpose under current law, a small business includes one that has no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2022, the limit is $27 million.

3. Section 179 deduction 

The Sec. 179 first-year depreciation deduction potentially allows you to write off some (or all) of your qualified asset additions in the first year they’re placed in service. It’s available for both new and used property.

For qualified property placed in service in tax years 2018 and beyond, the deduction rules are much more favorable than under prior law. Enhancements include:

Higher deduction. The Sec. 179 deduction has been permanently increased to $1 million with annual inflation adjustments. For qualified assets placed in service in 2022, the maximum is $1.08 million.

Liberalized phase-out. The threshold above which the maximum Sec. 179 deduction begins to be phased out is $2.5 million with annual inflation adjustments. For qualified assets placed in service in 2022, the phase-out begins at $2.7 million.

The phase-out rule kicks in only if your additions of assets that are eligible for the deduction for the year exceed the threshold for that year. If they exceed the threshold, your maximum deduction is reduced dollar-for-dollar by the excess. Sec. 179 deductions are also subject to other limitations.

Bonus depreciation

While Sec. 179 deductions may be limited, those limitations don’t apply to first-year bonus depreciation deductions. For qualified assets placed in service in 2022, 100% first-year bonus depreciation is available. After this year, the first-year bonus depreciation percentages are scheduled to start going down to 80% for qualified assets placed in service in 2023. They will continue to be reduced until they reach 0% for 2028 and later years.

Contact us to determine if you’re taking advantage of all available tax breaks, including those that are available to small and large businesses alike.

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Many people wonder how they can save taxes by transferring assets into their children’s names. This tax strategy is called income shifting. It seeks to take income out of your higher tax bracket and place it in the lower tax brackets of your children.

While some tax savings are available through this approach, the “kiddie tax” rules impose substantial limitations if:

1. The child hasn’t reached age 18 before the close of the tax year, or
2. The child’s earned income doesn’t exceed half of his or her support and the child is age 18 or is a full-time student age 19 to 23.

The kiddie tax rules apply to your children who are under the cutoff age(s) described above, and who have more than a certain amount of unearned (investment) income for the tax year — $2,300 for 2022. While some tax savings on up to this amount can still be achieved by shifting income to children under the cutoff age, the savings aren’t substantial.

If the kiddie tax rules apply to your children and they have over the prescribed amount of unearned income for the tax year ($2,300 for 2022), they’ll be taxed on that excess amount at your (the parents’) tax rates if your rates are higher than the children’s tax rates. This kiddie tax is calculated by computing the “allocable parental tax” and special allocation rules apply if the parents have more than one child subject to the kiddie tax.

Note: Different rules applied for the 2018 and 2019 tax years, when the kiddie tax was computed based on the estates’ and trusts’ ordinary and capital gain rates, instead of the parents’ tax rates.

Be aware that, to transfer income to a child, you must transfer ownership of the asset producing the income. You can’t merely transfer the income itself. Property can be transferred to minor children using custodial accounts under state law.

Possible saving vehicles

The portion of investment income of a child that’s taxed under the kiddie tax rules may be reduced or eliminated if the child invests in vehicles that produce little or no current taxable income. These include:

• Securities and mutual funds oriented toward capital growth;
• Vacant land expected to appreciate in value;
• Stock in a closely held family business, expected to become more valuable as the business expands, but pays little or no cash dividends;
• Tax-exempt municipal bonds and bond funds;
• U.S. Series EE bonds, for which recognition of income can be deferred until the bonds mature, the bonds are cashed in or an election to recognize income annually is made.

Investments that produce no taxable income — and which therefore aren’t subject to the kiddie tax — also include tax-advantaged savings vehicles such as:

• Traditional and Roth IRAs, which can be established or contributed to if the child has earned income;
• Qualified tuition programs (also known as “529 plans”); and
• Coverdell education savings accounts.

A child’s earned income (as opposed to investment income) is taxed at the child’s regular tax rates, regardless of the amount. Therefore, to save taxes within the family, consider employing the child at your own business and paying reasonable compensation.

If the kiddie tax applies, it’s computed and reported on Form 8615, which is attached to the child’s tax return.

Two reporting options

Parents can elect to include the child’s income on their own return if certain requirements are satisfied. This is done on Form 8814 and avoids the need for a separate return for the child. Contact us if you have questions about the kiddie tax.

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