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BUSINESS OWNERS HAVE far more control over their tax bill than W-2 employees. But only if you know how the rules actually work.
The tax code is structured to reward self employment, business investment, and retirement saving, yet many business owners leave significant money on the table simply because they are unaware of all the strategies.
If you are eligible, a Solo 401(k) plan can be an effective way to lower your taxes or shield your investments from future taxation.
The amount you can contribute to a Solo 401(k) depends on your self-employment income, your age, whether you participate in another plan (like having a 401(k) at a W-2 job), the type of contribution, and your business entity.
For example, say you are 40 years old and have an S corporation with which you pay yourself $100,000 of wages. You can contribute:
In total, you can contribute $48,500 to your Solo 401(k).However, if your Solo 401(k) plan allows, you may also take advantage of a strategy called the “Mega Backdoor Roth,” also known as the after-tax account.
Going back to our example, the maximum 401(k) contribution (employee + employer + after-tax) allowed under the rules is $70,000.
Since we already contributed $48,500, we still have $21,500 of room left (the maximum limit you can contribute to such a plan is $70,000, or $77,500 if age 50+, up to your compensation). You can contribute to an after-tax account and roll it over into a Roth 401(k) or Roth IRA.
This strategy is extremely useful for someone with a high-earning W-2 and a side hustle.
For example, if someone has $500K per year in W-2 income, already maxed out the employee side ($23,500) at their main job with no match, and has a $100K (net self-employment earnings) consulting gig on Schedule C, they can effectively contribute:
Having the right entity
If you are self-employed, you have to pay self-employment taxes (7.65% as the employee and 7.65% as the employer, for a total of 15.3%) if you are a sole proprietor.
However, you could elect your business to be taxed as an S corporation, which could potentially help you save money on self-employment taxes. You would have to pay yourself a reasonable salary and can take the rest of your income as a distribution.
As a rule of thumb, an S corporation could help you save once you make $100,000 net from your self-employment activity. But it comes with extra steps, such as:
So, it’s important to analyze the cost of the additional compliance fees to determine whether it’s worth it for your specific scenario.
Shifting income/expenses
Something that not a lot of people think about is how you can be strategic about the timing of your expenses and income.
Most self-employed business owners are on a cash basis. This means that they pay taxes on the cash that is constructively received, not when it is earned and services are provided.
This provides an opportunity to shift income depending on when you invoice and receive the money.
For example, say you are going to retire next year and your income will drop. In that case, it could make sense to bill a customer (for services provided) next year (the year of retirement) rather than in the current year.
Similarly, if you are experiencing incredible growth where you will make, say, $200K this year but are expecting $300K next year, it may make sense to postpone some of your expenses to the next year. For example, instead of upgrading your computer in 2025 and using bonus depreciation to write off 100% of the cost, you could buy it in 2026 instead and save money.
So it all depends on your current income and your projected income next year. If income will be higher next year, try to postpone expenses to next year. If income will be higher next year, try to realize as much income as you can this year.
Hiring your child
Hiring your child could be a legitimate tax and wealth-building strategy for business owners, but it must be done correctly. And it’s one of those strategies that is often abused or incorrectly set up.
Here are some tips:
The tax savings would depend on your circumstances (e.g. are you in a 37% tax bracket?)
Just have to make sure you do it legitimately and document (!).
Have you used any of these strategies? Let me know in the comments!
Bogdan Sheremeta is a licensed CPA based in Illinois with experience at Deloitte and a Fortune 200 multinational.
Good information. I have a friend who ran a very successful business for many years. Today he is retired mostly living on Social Security and help from kids.
One time I mentioned a couple of the plans you did. Turns out he has no investments of any kind “no time for any of that stuff” he said.
He never took advantage of any savings programs for self employed or small business. I can’t image that his accountant didn’t push it although maybe he did and this guy was too stubborn to listen to advice.
I was an S Corp. My wife and I were the only two employees, and our savings vehicles were SEP-IRAs. A family accountant (actually my dad’s) set everything up in 1995 and it worked out just fine. When the state tax paperwork grew too onerous a couple of years ago, I closed the corporation and now work just as an individual.
Having recently retired from full time employment in my chosen profession, I continue to enjoy doing consulting work in my field of expertise. For me, there have been two advantages: 1) Continuing to be engaged in work (1-2 day/week) that I still find fulfilling– but choosing to do so when it fits my interest and schedule; 2) Earning just enough income from my consulting to enable me to write-off all our household’s ACA, Medicare, Medigap, LTCI, dental, and vision premium expenses as “above the line” deductions so I can effectively make larger Roth conversions prior to my SS at age 70. I use some of that income to pay Roth conversion taxes.
The key is to use the IRA, and sure, if you thrifty and have the time, go for some of the other advantages.
Other than the mis and overuse of the term strategies, well written.
I avoid critiquing others’ writing to ensure they don’t critique mine
I operate my consulting business as a sole proprietorship. I’m not convinced that the extra work and expenses in setting up an LLC or other corporate entity comes close to being worth it to avoid a sliver of tax. And the SEP IRA has essentially the same contribution limit without any additional paperwork. Trying to keep it simple and workable.
LLC for me is more of a CYA liability shield vs a tax benefit.