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brewer12345 01-09-2011 12:33 PM

Small Business Tax Shelters Aside From Solo 401k?
DW has a small business operating as a sole proprietor. Since start up in 2003, the business never generated more than $5k a year so sheltering all of the income from income taxes was easy: 100% of the net profits could be tossed into her solo 401k. With the kids spending more time at school, DW was able to spend more time marketing the business and in 2010 netted about $15k. Early indications are that this year will be at least as good, possibly significantly better. If so, she will pretty quickly exceed the $16.5k limit on 100% deferrals into her solo k. While she would still be able to toss 25% of her earnings above $16.5k into the solo k, because of my earnings she will be looking at a 28% federal tax rate, a 6% state tax rate and 15.3% payroll tax rate on the money she cannot defer. This adds up to a marginal rate of close to 50% on the unsheltered earnings.

I am poking through Nolo and the IRS sites, but are there any other obvious ways to shelter more income from taxes? I am not interested in anything that does not fit within the letter of the law and her home office does not meet the definition of a home office we can depreciate against her business income.

Animorph 01-09-2011 02:22 PM

My understanding for sole proprietors is 20% of earnings can go to "profit sharing" for the solo 401k. All the examples I have seen include the initial $16.5k contribution as part of those earnings, so you can defer another $3k+ before seeing any taxable income. I'm also able to take the catch up $5.5k, allowing me almost $30k before having to pay taxes. However, this will be the first year I've had to take the profit sharing to cover my income, so hopefully TurboTax agrees with me.

I've looked around for anything to cut my top line a bit, but there's not much available. I'm already subtracting $3k for excess capital losses, I tried to minimize dividends last year. One thing that caught me was a state tax refund, which adds back into AGI. Might have to make sure I have to pay the state next time.

LOL! 01-09-2011 02:26 PM

I'm not sure if this applies, but Health Savings Accounts & Flexible Spending Accounts might be a possibility.

brewer12345 01-09-2011 02:41 PM

Animorph, I was fooling around with this calculator: Solo 401k Calculator | Solo401kCalculator.com

It appears you are right about how max contributions are calculated. As such, it looks like DW would have to net north of $23k to start incurring state and federal income taxes. Sweet.

HSAs and flexible accounts are probably not going to work because we have health coverage and a spending account through my employment. But will most definately be looking into such once I esr.

It looks a lot like DW has a lot more room to earn before we start getting hit with taxes.

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