Sole proprietorship and Solo 401k

[stephenson]

Doing a bit of research for my musician son. He works "full time" for large city orchestra and has lots of independent gigs and give lessons, etc.

If I understand his contract, funds are provided into a pension account by the orchestra company and these are professionally managed by the musicians union. He has also been contributing, since 18, to an IRA. He is very thoughtful about money, has already bought a fixer upper house, and drives an old car.

Since he has significant additional income annually, it appears a Sole proprietorship would allow him to contribute more into tax deferred account than he can with an IRA solely.

Has anyone use this sort of mechanism and do you think his type of employment would be a good fit? He's asked his fellow musicians about it, but no one he spoke with is using this construct.

Thanks!


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[gauss]

If he is currently paying all the taxes on his additional income (ie Federal, State, SE tax) then a solo 401k might be a good fit. I haven't done one myself due to the lack "additional income" on my part.

-gauss

 

[samclem]

If he wants to defer taxes on more money than he can in an IRA, then a Solo 401k on his self-employed income would be the best way. Paw around through the threads here, they've been covered a bit. Here's one.

 

[Animorph]

I liked my solo 401k, and I also had a Solo Roth 401k. Like the others said, it would only apply to self-employed income. But it should allow the largest contributions, the normal 401k limits plus a profit sharing amount.

On the other hand, that may be way more than he can afford to lock up in a retirement account. There are other more limited options available that that weren't right for me.

 

[jetpack]

I guess SEP IRA is simpler to set up. SEP vs. SIMPLE vs. Solo 401(k)

 

[target2019]

I guess SEP IRA is simpler to set up. SEP vs. SIMPLE vs. Solo 401(k)

That is a fine article.

When I set up my SEP-IRA, all I had was self employment income. I usually maxed my contribution. If I had 30k profit, then I contributed 6k to the SEP.

Later, when I was FT employed, SE profit shrunk to 6k. Then I felt limited by the SEP. I would have preferred to contribute much more of the profit.

It really helps to run a projection of the tax impact.

 

[MooreBonds]

Doing a bit of research for my musician son. He works "full time" for large city orchestra and has lots of independent gigs and give lessons, etc.

If I understand his contract, funds are provided into a pension account by the orchestra company and these are professionally managed by the musicians union. He has also been contributing, since 18, to an IRA. He is very thoughtful about money, has already bought a fixer upper house, and drives an old car.

Make sure he's taking all legitimate deductions as a professional musician and tutor. Things like mileage to tutoring sessions, depreciating business use of his home (if a certain part is only used for tutoring), health insurance premiums for a self-employed individual, and whatever he's allowed for depreciation of his instrument(s). By the time he takes all of those deductions, look at his marginal tax bracket. If he's just into one bracket by a little bit, it might make sense to see how much 401k deductions it would take to reduce it down to the next lowest bracket, and possibly (if it makes sense) put additional money into a ROTH IRA.

 

[Sunset]

As self employed, I use a self 401K via vanguard, the max limit for contributions is the normal $17,500 + 25 of net earnings (that is gross - expenses), this is limited to approx $51,000/yr.
The fee is $20/yr for it. Once set up, you can do ACH deposits as you like.
For the Solo 401K he would need to set it up in 2014 (does take couple of weeks) but has until April 15, 2015 to contribute for 2014 tax yr.
The one funny thing, is he will have to phone IRS to get a SSN (for his 401k accnt), which I thought was really weird, but the IRS is certainly used to it, and gave me mine immediately.
Vanguard has a lot of info on this page to explain choices: https://investor.vanguard.com/what-we-offer/small-business/individual-401k
They have both IRA and Roth versions and as MooreBonds said, its possible a Roth 401K would be better.

https://investor.vanguard.com/what-we-offer/small-business/individual-401k

 

[gauss]

As self employed, I use a self 401K via vanguard, the max limit for contributions is the normal $17,500 + 25 of net earnings (that is gross - expenses), this is limited to approx $51,000/yr.
The fee is $20/yr for it.

Am I correct in assuming that the $17,500 part would also be limited by any earnings?

-gauss

 

[RE2Boys]

Am I correct in assuming that the $17,500 part would also be limited by any earnings?

-gauss

Employee contributions to retirement plans are always limited by earnings.

 

[samclem]

The one funny thing, is he will have to phone IRS to get a SSN (for his 401k accnt), which I thought was really weird, but the IRS is certainly used to it, and gave me mine immediately.

Just to be technically accurate, it's an "Employer Identification Number" (EIN) that he'll need.

 

[gauss]

Just to be technically accurate, it's an "Employer Identification Number" (EIN) that he'll need.

For a solo 401k, is the EIN needed a separate and distinct number from the owner's SSN?

-gauss

 

[smurray5991]

For a solo 401k, is the EIN needed a separate and distinct number from the owner's SSN?

Yes, the EIN must be separate from the proprietor's personal SSN to open a solo 401(k). You can get this in a few seconds online at the IRS website, so it's no big deal.

 

[gauss]

Yes, the EIN must be separate from the proprietor's personal SSN to open a solo 401(k). You can get this in a few seconds online at the IRS website, so it's no big deal.

Okay, sounds similar to the process to get a distinct EIN to open up and Estate bank account. Thanks!

 

[stephenson]

Some great advice! Thanks to All.

Son and I have been discussing the advantages and he understands ... another consideration appears to be whether to set up a formal business construct such that there is audit-able continuity ... it sounds like most everyone who commented on the Solo 401K are considering this is being done within the construct of a formal business (sole proprietorship LLC) (given he has several sources of income, one of which is larger than the others, but also given that he would actually spend more of his "working time" doing the secondary jobs like side gigs, lessons, master classes at universities, and maybe even an adjunct professorship at a couple of local colleges)?

Does it seem reasonable (to the IRS) if he has a "mix" of income and the secondary income is significant percentage (it looks to be 10-20%) and he spends significant time and effort on the secondary (about 50% of the work time), that he would be able to include mileage and other expenses from the full time job, as well as secondary jobs?

And, to be clear - given this approach, say he makes $100K a year on the full time gig, and $20K a year on secondary jobs), what would be be able to "set aside" via 401K (given he has pension funds removed from his full time gross via the union contract)?

I'm trying to make the point to him to do the hard work of setting up the business so that he is base-lined with IRS and within their general guidelines from the beginning.

Very much appreciate the comments and thoughts and advice!

 

[samclem]

And, to be clear - given this approach, say he makes $100K a year on the full time gig, and $20K a year on secondary jobs), what would be be able to "set aside" via 401K (given he has pension funds removed from his full time gross via the union contract)?

The Solo 401K is independent of, and not affected by, the pension he has with his full-time job. If he earned 20K in this solo employment, then from >that income< he'd be able to put away, tax deferred, $17,500 (the "employee deferral" that is a fixed dollar amount and can even be his entire income from this work if he earns $17,500 or less) plus up to about 20% of the total business net income (= approx $4000 in this case). It's "about" 20% because there's some interplay with the Self Employment Tax. If he earned $20K, he could put every dime into a SOlo 401K--AFTER he's paid the approx 15% Self Employment Tax (which covers his SS and Medicare contributions). So, he won't get away without paying taxes entirely. And, he'll eventually have to pay tax on all of this money, it's just deferred to a later time. For many folks in their lower-income first years of employment, a Roth Solo 401K can make more sense (because they are paying taxes at a lower rate today then they will be when they are older--better to pay the tax now).

I'm trying to make the point to him to do the hard work of setting up the business so that he is base-lined with IRS and within their general guidelines from the beginning.

Your advice is sound, but be careful not to scare him off with the "hard work" part. This doesn't have to be hard at all. He doesn't necessarily need an LLC (I don't have one, and I probably wouldn't set one up in his shoes unless he's got some sort of liability exposure that seems unlikely in his line of work). Just get a short book on setting up a business, learn how to keep records, and set up the Solo 401K as a sole proprietor.

 

[target2019]

Note that commuting miles are not deductible.

Grab a schedule C and see what is there. There is an IRS publication that covers small business topics and schedule C.

Sole proprietor sounds as if it is sufficient in his case.

 

[Sunset]

stephenson : I would not say its hard work to set up the business, really its just a matter of tracking the income paid and expenses for that gig each time. Payments go to your son (his SSN).
He cannot deduct mileage for driving to his employee job or lunches at his employee job. I'm trying to make the point that his employee job stuff is separate from his self employment stuff.
It is totally fine to have more than 1 way of making $$$ when Self employed, especially in this case where doing gigs/teaching music/giving lessons are essentially come from the same skill/ability.
If his employee job allows him to contribute to a 401K then his Self employment contribution of the $17,500 is reduced by how much he contributes on his employee job. (you are not allowed to double up your contribution, otherwise some folks would have 4 Self employments and contribute $70K and pay no tax)

 

[samclem]

If his employee job allows him to contribute to a 401K then his Self employment contribution of the $17,500 is reduced by how much he contributes on his employee job. (you are not allowed to double up your contribution, otherwise some folks would have 4 Self employments and contribute $70K and pay no tax)

Good point, thanks for the correction.

 

[Sunset]

If his employee job allows him to contribute to a 401K then his Self employment contribution of the $17,500 is reduced by how much he contributes on his employee job. (you are not allowed to double up your contribution, otherwise some folks would have 4 Self employments and contribute $70K and pay no tax)

Lets pretend his regular job as regular-employee had a 401K and he contributed the max to it ($17,500) plus his regular-employer chipped in some matching amount (it does not matter how much).
He would still be able to contribute the 25% of Net income (minus the SE tax, which is closer to 20% number due to complex calculations) as the "employer portion" of his own self employment income.
Because when self employed you son will be both self-employee and self-employer.

 

[target2019]

SEP-IRA is not limited by 401k contributions. Not sure about the other plans being discussed.

 

[stephenson]

OK - so still considering how to increase number of deductions ...is there a point at which his primary (I am calling it this because it does not take 40 hours per week and is so time-shared with secondary activities as to blur) job's time/income mandates that it be the "full time" position we usually understand? Is there something specific that makes it this? Some ratio of it to other jobs? What, for instance, if he played "full time" with two different orchestras (this happens sometimes, just not to him, yet) ... both could not be "full time" but would rather be two large jobs with several other smaller ("secondary") jobs ...guess am asking if being a professional musician means the edges between jobs are so ill defined that the old considerations are arguable?

 

[Sunset]

A person can have 10 jobs, if that person gets a W2 at say 3 of them, then any expenses associated with those 3 W2 jobs generally cannot be deducted.
The other 7 jobs a person has are the SE (self employment) ones and he would just list as Self employed income (from all 7) = X, expenses from (from all 7) = Y and those are the deductions, and he would have 1 self-401K (my favorite) based on the 7 SE jobs.
Does not matter if the other 3 W2 jobs take 10 hours per week total or 100 hrs/week. Its the classification of the job that determines if he can deduct expenses.
Note: in my 7 SE jobs, I did not include (mentally) the thing we call hobbies, the IRS is clear about hobbies, so if you really don't sell or make $$$ from it, then it might be considered a hobby and not deductible.

There is nothing stopping him in his SE role from buying a new Stradivarius and as long as he could claim he used it mainly in his SE jobs, the occasional use in a W2 job would not hurt the deduction claim.

 

[stephenson]

OK - getting it now

If he gets W-2 vice MISC is related, likely to full status of the job - contract, longer term, health care, pension, etc potentially as part of the "package."

He and I were just discussing current situation ... his orchestra has been locked out by management and federal mediator has been agreed to and is negotiating with both sides - he has taken a fill-in job with another orchestra or six weeks or so - we think expenses related to this part time employment can be deducted as any local area gig would be - I've recommended he simply take the GSA food/misc per diem deductions vice trying to pull together every receipt for every meal, etc. He can also deduct mileage for his car for both the relocation and the back/forth to the part time job. He already has additional smaller jobs in the temporary area, so there will be multiple sources.

 

[samclem]

I've recommended he simply take the GSA food/misc per diem deductions vice trying to pull together every receipt for every meal, etc.

That's what I usually do, because I usually spend less on meals than the GSA rate. He may later need to prove that he was in the cities he claims to have been in--lodging, gas, or meal receipts can help with that, so I make it a practice to charge things when I travel for business. Be aware that you can't mix and max--if he goes with actual expenses VS the GSA rate, he has to use that all year.

Also, be sure to look at the rules for "business travel" vs "commuting". "Commuting" costs are not deductible.