Tax Benefits

Can a Self-Directed Solo 401(k) help me deduct my taxes? Show me the math on how I can save.

The example below walks through a typical Rocket Dollar member who saves on taxes with their Self-Directed Solo 401(k) account.

Let's assume you have a side business as a sole proprietor or you run a business as a single-member Limited Liability Company (LLC) moonlighting as a consultant. Taxes are paid by the member of the single-member LLC, not the entity itself. The IRS considers the LLC a pass-through entity for tax purposes. It's likely you will need to fill out an IRS Schedule C to report the money you made or lost in your business. This form, titled "Profit or Loss From Business (Sole Proprietorship)," must be completed and included with your income tax return.

So, let's say the business earned $100,000 after deducting Schedule C (or C-EZ) expenses such as travel, entertainment, advertising, software vendors, and salary as compensation. (For self-employed individuals, compensation means earned income.) The operating profit is $100,000.

First, we calculate 1/2 of the self-employment tax. The self-employed person's FICA tax rate for 2018 (January 1 through December 31, 2018) is 15.3% on the first $128,400 of net income, so your net self-employment earnings are $92,350 ($100,000 - $7,650).

You can contribute 20% of your net self-employment earnings, which amounts to $18,470. Your profit after the employer contribution (or profit-sharing contribution) is $63,030. (This article assumes you're operating as a single-member LLC. Note that profit-sharing contributions are limited to 25% of your compensation from an S-Corp, C-Corp, partnership, or multi-member LLC).

Next, we subtract the self-employment tax of 15.3%, which comes to $9,644. Your net profit is now $53,386.

With the employee salary deferral in the Self-Directed Solo 401(k), you could contribute $18,500. You've now contributed a total of $36,970 to your Self-Directed Solo 401(k) and your taxable income is now $34,886.

With the standard deduction of $12,000 for individuals in 2018, your taxable income is actually $22,886.

You can defer an extra $6,000 if you are above age 50 in a catch-up contribution.


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