As we begin tax season 2023, small business owners are likely looking for ways to lower their tax bills for 2022. Hopefully, you are sitting on record profits for your highly successful business. However, record profits often mean record taxes. One of the best ways to lower last year’s taxes is to fully fund a small business retirement plan.
If you are one of these small business owners facing a large tax bill, you may wonder whether you still have time to open a new retirement plan for your business (or self-employment income) for 2022. The exact answer for your situation will likely be, “it depends.” Keep reading to find out the best retirement plan for your small business to help lower your 2022 taxes.
Tax planning offers excellent opportunities for business owners to improve their after-tax profitability. A few retirement plans are specifically designed to help small business owners. The most used are SEP-IRAs, solo 401(k) plans, and cash balance pension plans. Each has its pros and cons.
What Is the Deadline to Open a SEP-IRA for 2022?
Generally, the SEP-IRA is the easiest small business retirement plan to open. And yes, you can still open and fund a SEP-IRA for 2022. You can open a SEP-IRA plan as late as your tax-filing deadline, including extensions.
Contributions to a SEP-IRA are limited to 25% of your income or $61,000, whichever is smaller. Many business owners can contribute more to a solo 401(k) than a SEP-IRA. Keep in mind a SEP IRA is best for those businesses without employees.
Establishment Deadlines for the Solo 401(k) Plan
There is confusion around deadlines for establishing a new solo 401(k) for the previous year. New rules under the SECURE Act include allowing extra time for business owners to set up new non-IRA retirement plans, including the solo 401(k). Previously (under the prior rules), new solo 401(k) plans had to be established by December 31 of the tax year. The good news is, going forward; you can set up a solo 401(k) up until the due date for the corporate tax returns, the same deadline as for SEP-IRAs. But there are limits to contributions when opening a solo 401(k) after the tax year has ended. (So, it is best to open it during the tax year when possible).
When opening a new solo 401(k) after the tax year ends, you will only be able to make employer contributions – not employee elective deferrals. According to the IRS, self-employed workers must make their deferral elections by 12/31/2022 (for the tax year 2022).
Without 2022 elective deferrals, it will be harder to get the maximum amount allowed into a solo 401(k) for 2022. The maximum 2022 contribution for a new solo plan adopted in 2023 is $61,000. If the new 401(k) plan had been established in 2022, the contribution limit for owners who are 50 or older would have been $67,500 if the $6,500 elective deferral catch-up contribution had been used.
Cash Balance Plan Establishment Deadline
For high-income business owners, great news about cash balance plans was hidden in the SECURE Act. Like the solo 401(k), the deadline to establish a cash balance plan has been extended to your tax-filing deadline, including extensions. Unlike the solo 401(k), all contributions to a cash balance plan are from the employer.
In plain English, you can set up and fully fund a cash balance plan in 2023 for 2022. You can potentially lower your taxable income by hundreds of thousands of dollars. Depending on your corporate structure, here are your deadlines: S-Corp or Partnership, March 15 (September 15 on extension) and C-corp or Sole Prop, April 15 (October 15 on extension).
Maximizing the tax savings of a cash balance plan and 401(k) could reduce your taxable income by hundreds of thousands of dollars per year. This could add up to over a million dollars in tax savings over the next decade, depending on your income and state taxes.
Talk with your tax-planning expert and financial planner to see which small business plan will best suit you for the tax year 2022. From there, you can make the choice of which small business retirement account will provide the most tax savings going forward in 2023 and beyond.