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New Calculator: Solo 401(k) Contribution Limits

Self-employed retirement plans — SEP IRAs, SIMPLE IRAs, and solo 401(k)s — are one of the topics people ask me about most frequently. Of the three, people ask most often about solo 401(k) plans because:

  1. They have the highest contribution limits, and
  2. Calculating your contribution limit can be rather complicated.

There are plenty of online contribution calculators of course, but many of them (e.g., Fidelity’s or Bankrate’s) provide the wrong answer in some cases. There are some calculators (e.g., Vanguard’s or TurboTax) that get the right answer reliably, but they offer no accompanying explanation of where the answer came from, so they have limited usefulness as learning tools.

So I recently decided to make my own, which both calculates the contribution limit and explains how that limit was calculated. You can find the calculator here:

Please take a look at it. If you have any suggestions of ways to make it better, I’m all ears. (Though to be clear my coding skills — especially javascript, in which the calculator is written — are decidedly beginner-level.)

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

Solo 401(k) Contribution Limit with Another Job

A reader writes in, asking:

“For the first 9 months of 2016, I have been considered a self-employed 1099 contractor at a hospital. As of October 1st, I will be a W-2 employee, but I will be doing the same work at the same hospital.

If I have sufficient earnings as a 1099 contractor for that 9-month period in 2016, will I be able to contribute a full $53,000 to my Solo 401k with that contribution being funded as ’employer’ contributions while also contributing up to $18,000 to my 401k as an employee for the period of October 1, 2016 – December 31, 2016?”

Short answer: Yes.

[Quick note: With what follows, I am assuming that the reader is familiar with the basics of solo 401(k) contribution limits. If you are not, I’d suggest reading up on them before proceeding.]

The employee salary deferral limit for 401(k) plans (i.e., $18,000 for 2016) is a per-person limit. That is, any deferrals that are made to the plan at your job as an employee will be counted against the $18,000 limit for deferrals (i.e., “employee” contributions) to the solo 401(k) — and vice versa.

The $53,000 annual limit works differently though. This limit comes from IRC 415(c). The key point when reading that Code section is to understand that these are the rules for a given plan, rather than for a given person. That is, the plan wouldn’t be a qualified retirement plan if it let a participant contribute more than $53,000, but there’s no rule saying that a given person isn’t allowed to make more than $53,000 of total contributions if they are a participant in multiple plans.

This article from IRS.gov provides a very clear example:

“Greg, 46, is employed by an employer with a 401(k) plan and he also works as an independent contractor for an unrelated business. Greg sets up a solo 401(k) plan for his independent contracting business. Greg contributes the maximum amount to his employer’s 401(k) plan for 2015, $18,000. Greg would also like to contribute the maximum amount to his solo 401(k) plan. He is not able to make further elective deferrals to his solo 401(k) plan because he has already contributed his personal maximum, $18,000. He has enough earned income from his business to contribute the overall maximum for the year, $53,000. Greg can make a nonelective contribution of $53,000 to his solo 401(k) plan. This limit is not reduced by the elective deferrals under his employer’s plan because the limit on annual additions applies to each plan separately.”

Caution: Shared Ownership

While the $53,000 limit is a per-plan limit, it’s important to understand that, in some cases, multiple retirement plans will be aggregated (i.e., considered to be one plan). IRC 415(g) and 415(h) provide the relevant rules.

Specifically, multiple businesses will be aggregated as part of a “brother-sister controlled group” if five or fewer individuals (including people, estates, and trusts) own more than 50% of the stock of each business (measured in terms of voting power or value). Alternatively, two businesses will be aggregated as part of a “parent-subsidiary controlled group” if one business owns more than 50% of the other business (again measured in terms of voting power or value).

For example, if you are the sole owner of two single-member LLCs, those two LLCs will be aggregated for these purposes (and you will not be able to exceed the $53,000 total contribution limit), even if the two LLCs operate in completely different industries.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

Is It Better to Be Taxed as an Employee or Independent Contractor?

A reader writes in, asking:

“I just started a new position and the company is letting me decide whether I want to be taxed as an employee or an independent contractor. What factors should I be considering in order to make this decision?”

Firstly, we need to back up a step, because this question sets off some alarm bells.

It is the facts and circumstances of the work relationship that determine whether a worker is an employee or an independent contractor. Generally speaking, the more control the business has over the worker, the more likely it is that the worker is an employee rather than an independent contractor. (IRS Publication 15-A has more details.)

In other words, if the facts and circumstances of the work suggest that you are an employee, the business cannot simply decide you are an independent contractor and handle everything accordingly. And in fact many employers get in trouble with the IRS every year as a result of having misclassified their employees as independent contractors.

The key point here is that, in the event that you really do have a choice between being an independent contractor or an employee (i.e., it is not simply a case of the business misunderstanding the rules and thinking that they can treat you as either one without any substantial difference in the work relationship), there are going to be factors other than taxation involved.

So What Are the Tax Differences?

From a tax perspective, there are both pros and cons regarding the tax treatment for independent contractors as compared to employees.

As an employee, you are responsible for paying Social Security and Medicare taxes in the amount of 7.65% (2.9% for amounts beyond the current Social Security earnings limit), and your employer pays a matching amount. As an independent contractor, you have no employer, so you get stuck with both halves of the bill (in the form of a 15.3% self-employment tax).

Another disadvantage of being an independent contractor is that it requires somewhat more administrative work. You’ll have to fill out Schedule C along with your Form 1040 every year to calculate the profit or loss from your business. In addition, because nobody will be withholding taxes from your income, it will (in most cases) be necessary for you to make estimated tax payments throughout the year.

On the other hand, one advantage of independent contractor tax treatment is that your work-related expenses will be business expenses, which will save you money on income tax as well as Social Security and Medicare taxes. In contrast, as an employee, unreimbursed work expenses are generally itemized deductions, meaning that you get no value from them if you use the standard deduction each year. In addition, they’re in the category of itemized deductions from which you must subtract 2% of your adjusted gross income before even being allowed to include them as an itemized deduction. (See the instructions to Schedule A for more information.)

An additional advantage of being an independent contractor is that you’ll have additional retirement plan options available to you. Most importantly, you’ll be eligible for a solo 401(k) — alternatively referred to as an individual 401(k) — for which the contribution limits are quite high.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

Solo 401(k) Contributions: Employee or Employer?

A reader writes in, asking:

“I have a solo 401k at Vanguard. There’s no way I will hit the total contribution limit for the year, so should I be making employer or employee contributions to the account?”

As background information, if you are a business owner with a solo 401(k) — sometimes referred to as an individual 401(k) or self-employed 401(k) — you can make two types of contributions to the account:

  • An “employee” contribution, limited to $18,000 ($24,000 if age 50 or over) for 2016, and
  • An “employer” contribution, limited to 25% of your net earnings from self-employment (if you are a sole proprietor or LLC taxed as a sole proprietorship) or 25% of your compensation (if you are an owner-employee of an S-corp or LLC taxed as an S-corp).

Solo 401(k) for Sole Proprietors

For a sole proprietor, pre-tax (i.e., “traditional”) contributions (whether they’re employee or employer contributions) will be deducted on line 28 of Form 1040 under “Self-employed SEP, SIMPLE, and qualified plans.”

Because pre-tax employer and employee contributions are deducted in the same way, neither one is more tax-efficient than the other.

That said, because employee contributions can be Roth or pre-tax, whereas employer contributions can only be pre-tax, if you want to make pre-tax contributions, it often makes sense to make them as employer contributions (to the extent possible), thereby saving your (more flexible) employee contribution space, in case you decide that your further contributions should be Roth rather than pre-tax.

Solo 401(k) for S-Corporation Owner/Employees

If your business is taxed as an S-corporation, contributions that you make as an employee would reduce the amount of wages that would appear in box 1 on your W-2 — and therefore the amount of wages that show up on your Form 1040. Note that they do not reduce the amounts that show up in boxes 3 and 5 (“Social Security Wages” and “Medicare Wages”). In other words, these contributions reduce your income tax, but they do not reduce your payroll taxes.

Employer contributions to the solo 401(k) would show up on line 17 of Form 1120S as “Pension, profit-sharing, etc., plans.” This would reduce the amount of income from the S-corporation that would be passed through to you as the owner, thereby reducing your income tax. But, because this income is not subject to payroll taxes in the first place, these contributions will not reduce your payroll taxes.

In other words, for an S-corp owner-employee, employer and employee pre-tax solo 401(k) contributions are equally advantageous (just as they are for a sole proprietor). Though again, by prioritizing employer contributions, you preserve your more flexible employee contribution space, in case you decide you want to make Roth contributions later in the year.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

Self-Publishing FAQs

Mike’s note: This article was originally published in February of 2012. But there has been an increase in questions from readers about self-publishing lately, so I’m updating the article and republishing it with current information. For readers with no interest in the topic, don’t worry, I have no intention of discussing book publishing on a regular basis.

Aside from the usual financial planning-related questions, the most common thing readers ask me about is self-publishing — how to do it, how to get a book on Amazon, which printing company to use, how to market books, etc.

What follows are the answer to the questions I’m asked most often. If you have any questions left unanswered, feel free to ask via email.

Of note, this article is written from the perspective of a writer whose goal is to publish a book as an entrepreneurial endeavor. If your goal is simply to publish a book, and you have no goal of any financial reward, you can read the first FAQ below and ignore everything else.

Print Publishing

Which printing company do you use?

CreateSpace. Their costs are low, and they’re easy to use.

I also have printing set up with a second company (Lightning Source), so that the books are still available while they are being updated. (I update 3-5 books each year. And while a book is being updated with a given printing company, it must be taken out of distribution with them.)

But for most writers though — especially anybody just getting started — I’d suggest sticking with CreateSpace alone.

What do you have to do to get a book selling on Amazon?

If you’re using CreateSpace, it’s easy:

  1. Create an account,
  2. Send them a pdf of the cover and a pdf of the interior,
  3. Order a proof copy and check it over,
  4. Submit necessary revisions,
  5. Repeat steps 3 and 4 as necessary, then
  6. Approve the proof.

After you’ve approved your proof copy and checked the box for distribution via Amazon, it will automatically be available for sale within a few days.

How much money do you make from a book sale?

With CreateSpace, your revenue per unit (for a black and white book) will be calculated as follows:
60% of the book’s list price (which you set), minus
$0.85, minus
$0.012 per page.

So, for example, for a book with 150 pages and a $15 list price, you’d receive:
$9.00 (60% of $15)
-$0.85
$1.80 (150 pages x $0.012 per page)
$6.35 profit margin per book

How much money can I make by self-publishing a book?

There’s no way to know ahead of time how much a given book will make. I’m happy to share some information though, because I know it’s helpful to at least have some idea. For the twelve months ending 7/31/15, five of the eight books in the “…in 100 pages or less” series generated revenue of between $10,000 and $20,000. One book generated less revenue than that, and two books generated more revenue than that.

From what I’ve heard from other financial self-publishers, that range is fairly typical, subject to the following caveats:

Caveat #1: If you make a book about a topic that very few people have an existing interest in, or if you don’t bother putting in the time to market your book, your sales will probably be much lower.

Caveat #2: These figures include both a print edition and a Kindle edition for each book. For the last 12 months, Kindle sales were responsible for 26% of my sales revenue. (This figure grew quickly from 2010-2011, but has since leveled off.)

How much does it cost to get started?

With CreateSpace, the cost is negligible. Setting up a book is free. Each proof copy costs about $20 including shipping. That’s it.

If you want to sign up with Lightning Source, there are more upfront costs involved. Plan on spending a few hundred dollars to get the book into distribution.

You may also want to buy an ISBN for the book rather than using one from your printing company. This will allow you to choose your own publisher name. (Otherwise, the printing company will appear as the publisher.) In the U.S., one ISBN costs $125. A block of ten costs $295.

That’s it as far as costs for the actual printing. However, I’d definitely encourage you to budget for professional editing services (both regular editing and technical editing) as well as cover design.

Why sell a book on Amazon rather than direct-selling ebooks to visitors?

The primary reason is that you get to take advantage of Amazon’s millions of visitors. This allows you to be successful with less of your own traffic, and without having to get other bloggers to promote your book.

Also, once the Amazon marketing engine starts promoting your book, it generally continues to do so. (My understanding is that with the direct-sales model, sales tend to decline dramatically after the first couple months of promotional effort.)

Finally, there’s no need to handle any sort of customer interaction at all. It’s passive income once the book is selling.

That said, those are just the advantages. There are disadvantages too. For example, you’re unlikely to get away with charging $50 for a book on Amazon. In addition, you’re not in control of what people say. If people don’t like your book, you’ll end up with negative reviews on the book’s sales page.

Do you have to keep a lot of inventory on hand? Is it a hassle to mail books out all the time?

You don’t have to do anything involving inventory or shipping. Amazon and the printing company handle all of it.

Kindle Publishing

How do you make a Kindle book?

For the most part, a Kindle book is just plain old HTML. However, rather than create the Kindle files yourself, it likely makes sense to outsource the conversion process. Because conversion from a Word document to an HTML document is a commodity-esque task, you can get it pretty cheap. (It’s easy to find people who will do a good job for less than $200 per book.)

How much do you make per Kindle book sale?

If you set the list price for your Kindle book between $2.99 and $9.99, your margin per book will be 70% of the list price, minus a “delivery fee” for the cost of transmitting the data. This fee is quite small. ($0.05 is typical for my books.)

If you set the list price for your Kindle book below $2.99 or above $9.99, your margin per book will be 35% of the list price, minus the data delivery fee.

Book Marketing

What’s your most important marketing tip?

Make a book that satisfies a need that people already know they have.

My most successful approach for book creation and marketing has been to:

  1. Find a specific question that people are asking. (Even better: Check your blog’s analytics to see what questions you’re already getting traffic for.)
  2. Answer that question as a chapter in a book.
  3. Answer several related questions as your other chapters. (Bonus points if you’re already getting traffic for these questions too.)

How do you promote your books on your site?

For me, by far the most successful spot for book promotion has been right at the bottom of each post. I simply have a paragraph that says, “for more information about [topic of book], consider picking up a copy of my book: [title].” Then it has an image of the book cover and several links to the sales page on Amazon. (See the bottom of this post for an example.)

I also use a widget that promotes my most-related book in the sidebar of every post. But it gets a much lower conversion rate than the end-of-post promo.

How do you get book reviews?

It depends which type of review you’re talking about.

In my experience, reviews from independent bloggers (as opposed to people writing for larger publications) are usually only of minor importance. It would be typical for a very positive review to sell just a few copies of your book.

Conversely, positive customer reviews on Amazon are tremendously helpful. My most successful method of getting customer reviews has been to include a prominent section at the front of the book requesting feedback from readers. When you get compliments, thank the person, and ask if they’d be so kind as to copy/paste the compliment into a review on Amazon.

Again, if you have other questions, please feel free to ask.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

How is a Sole Proprietor Taxed?

I recently received the following question from a reader:

“I’ve earned a significant amount this year so far in self-employed income. Is there anything special I need to be doing taxwise before actually doing my taxes next April?”

I know many of you earn self-employment income, so I thought it’d be worth addressing as a blog post. In brief, yes, there are a few things you should be doing. Specifically:

  1. Keeping records,
  2. Making estimated tax payments (maybe), and
  3. Saving money (maybe).

Keeping Records for Your Sole Proprietorship

It’s important to track your business transactions if you want to be able to claim every possible deduction come tax season. An easy way to do this is to set up a spreadsheet with columns for the date, description, and amount of each transaction. This way, when tax time rolls around, you’ll have all the necessary information in one place.

If you have more than a handful of business-related transactions each year, your best bet is to open a separate checking account for your business. That way, you won’t need to bother with recording every transaction, because the bank statements from your business checking account will have all the necessary information already.

Note: For the purposes of protecting yourself against an audit, you’ll actually need to do a little more recordkeeping — in addition to keeping bank statements (and/or credit card statements), you’ll have to keep receipts for your business expenses.

Making Estimated Tax Payments

Unlike salary or wages from a normal job, payments made to your business will not have anything withheld for taxes. As a result, you may end up needing to make estimated tax payments throughout the year.

In order to avoid interest or penalty, over the course of the year, the sum of your withholding (if any) plus your estimated tax payments must equal the smaller of:

  1. 90% of your tax for this year, or
  2. 100% of your tax from last year (Line 60 from Form 1040).

For many people who start a business in addition to their normal job, no estimated tax payments will be required in the first year, because the withholdings from their normal job are sufficient to meet requirement #2.

Saving Money to Pay Taxes

Even if you don’t have to make estimated tax payments (because the withholding from your or your spouse’s “real job” will be equal to your total tax from last year), you’ll still probably want to start saving now for next tax season. It’s likely that instead of getting a refund this year, you’ll be writing a check to the US Treasury.

When attempting to estimate how much you need to save, be sure to remember that income from a sole proprietorship is also subject to self-employment tax (calculated as roughly 15% of the net profit from your business) in addition to being subject to income tax at your current tax rate.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."
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