BENEFITS

401(K) Plans

Many entrepreneurs choose to establish 401(k) plans since they offer higher contribution limits and provide features other qualifying plans do not (tax-free borrowing, Roth option, etc.) and can be established by both sole proprietors and business owners with employees. In 2022, your 401(k) contribution / deduction could include up to $20,500 of elective deferrals (amount of your compensation you choose to put into the plan) plus an additional employer contribution of up to 25% of your compensation. Typically, you do not pay income tax on amounts you put into your 401(k) until you withdraw the funds (presumably when you retire). Further, you can deduct contributions to your own plan, and contributions to the plans of your employees, which can add up to create significant tax savings.

REAL ESTATE AGENT

Jan is a 43 year-old independent old real estate agent based in Charleston, South Carolina. In 2022, Jan had $110,000 of commission income. To minimize her current year tax liability and help save for retirement, she made an elective deferral of $20,500 to her solo 401(k). Jan would report this elective deferral on line 28 of her Form 1040, not her Schedule C. Also note that Jan will have to pay income tax on her elective deferral when she begins withdrawing money from her 401(k).

PROFESSIONAL SERVICES

Dean is a 35 year-old architect and owner of a single-member LLC. In 2022, Dean had $138,000 of self-employment compensation. He opted to make the maximum $20,500 elective deferral and an additional employer contribution of $13,800 (10% of compensation, however, up to 25% employer contribution allowed) to his 401(k). When Dean prepares his taxes, he will be able to deduct $33,300 ($20,500 elective deferral + $13,800 employer contribution) on his Form 1040. Since the contributions to his 401(k) were not to employees, Dean would not report the elective deferral or employer contribution on his Schedule C.

ENTREPRENEUR

Carrie owns a small editorial department in Boston, Massachusetts and has one employee. In 2022, Carrie made an elective deferral of $10,000 to her 401(k) and a matching employer contribution of $2,000 to her employee's 401(k). Carrie could deduct her $10,000 elective deferral on her Form 1040, and the $2,000 employee match she paid on line 19 of her Schedule C, reducing her annual taxable income by a total of $12,000.

PHOTOGRAPHER

Shoshana is a freelance photographer with one employee. Last year she had net self employment compensation (after retirement contributions and deductible self employment tax) of $55,000, her employee was paid a total of $32,000. Shoshana made the maximum $20,500 elective deferral for herself and a 2% employer contribution for her and her employee. In 2022, Shoshana could deduct her personal 401(k) contributions of $19,600 ($20,500 elective deferral + (2% * $55,000 employer contribution)) on her Form 1040, and $640 (2% x $32,000) of employer contributions on line 19 of her Schedule C.

UBER DRIVER / RIDESHARE

Kittel is 51 and drives full-time for Uber. In 2022, he earned $65,000 from his rideshare business. Since he is trying to catch-up on saving for his retirement, he chose to take advantage of the $6,00 catch-up contribution available to individuals over 50 years old and contribute $24,500 ($20,500 max elective deferral + $6,000 catch up) to his Roth 401(k). Even though Kittel's contribution was within IRS limits, he would not be able to deduct any of his $24,500 contribution since Roth contributions are after-tax. However, Kittel will likely be able to withdraw his $24,500 contribution tax-free when he retires, whereas he would need to pay taxes on withdrawals if he had made the same contribution to a regular 401(k).

UNDERSTANDING 401K TAX DEDUCTIONS

In 2022 If you have a 401(k), you are eligible to contribute up to $20,500 of your compensation as an elective deferral plus make an additional employer contribution of up to 25% of your total compensation. Note that your total elective deferral and employer contribution cannot exceed $55,000. Also, if you are age 50 and above, you are allowed to contribute and deduct an additional $6,000 catch-up contribution, increasing your elective deferral limit to $24,500 and total contribution to $61,000 in 2020.
When calculating your maximum employer contribution, you must reduce your self employment income by the the non-deductible portion of your self employment tax and by contributions to your retirement plan.
If you are a sole proprietor with a solo 401(k), while more onerous than a SEP IRA, typically the plan administration, testing and reporting requirements you must comply with are limited.
You can have a solo 401(k) or establish a 401(k) plan that will cover your employees as well. Generally, if you have employees, they will need to be covered by your plan. However, you can define requirements surrounding your plan including eligibility to participate, employer match %, vesting schedules, etc. Note that if you have employees, additional 401(k) reporting and administration requirements will likely apply to you.
If you have a 401(k) plan, contributions you make for yourself (including your employer contribution) are deductible on line 28 of your Form 1040 (excluding elective Roth deferrals). Contributions you make for employees are deductible on line 19 of your Schedule C.
There are many details surrounding 401(k)'s that we have not included on this page. Different guidance may apply to you depending on your specific situation. Further, 401(k)'s are just one of many investment vehicles you could choose to take advantage of. You should consult with your tax advisor and financial planner to determine how this deduction could apply to you specifically.

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IRS FORMS

Schedule C

IRS PUBLICATION

Retirement Plans

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