Tax season is here, which can be a treacherous time for small business owners who have avoided proactive tax planning. If you find yourself with a higher-than-expected tax liability for 2022, opening and fully funding a SEP IRA may be a way to slash your 2022 taxes. To benefit from a SEP IRA, you should be self-employed or at least have some 1099 income. The larger your income, the more significant the tax savings can be from a SEP IRA.
The Simplified Employee Pension Plan, aka SEP IRA, is a retirement account for self-employed people or those who own their businesses. This is more like a 401(k) than a pension. One of the best features of the SEP IRA is that it can be set up and funded between the year’s end and filing your taxes without any major reductions in the amount you can contribute.
If you are self-employed, cash flow is often an issue. The SEP-IRA allows flexibility when it comes to making your 2022 contributions. Making large or small deposits over time or making a one-time deposit when you get threatened with a huge tax bill from your accountant is one of the biggest benefits of a SEP IRA.
2022 Contribution Limits for a SEP IRA
You can sock away up to a fourth of your income up to the maximum limit. For 2022, that number was $61,000. If you are looking ahead to 2023, you can contribute another $5,000 for a total of $66,000 per year. All your contributions will be tax-deductible. The only drawback to these plans is they don’t come with a catch-up provision for those over 50. (A reason to consider a solo 401(k) for 2023 if you want to put away as much money as possible). For those looking to make even larger retirement plan contributions, check out the cash balance pension plan, which could allow you to shelter several hundred thousand dollars of income from taxation each year.
Related: Tax Savings From Hiring Your Spouse
Who Benefits the Most from a SEP IRA?
A business owner who works as a sole proprietor on up to an LLC, Partnership, S or C Corp can benefit most from a SEP IRA. If your business has employees, you may need to contribute to them the same percentage as you give to yourself. Making contributions for your employees may be fine, but it can mitigate some of the tax savings. For a business with multiple employees (beyond your spouse), you will likely see more benefit from a well-designed 401(k) profit-sharing plan.
These plans can be a godsend for business owners facing huge tax bills. (Don’t they always seem huge?) Remember, you can still open and fund a SEP IRA for 2022. I often have my financial planning clients ask their tax preparers to calculate the maximum amount they can contribute for the previous year. Would you rather write a check to yourself or the government? That scenario is pretty much a no-brainer. Don’t you think?
If you find yourself getting surprisingly large tax bills every year, congrats on running a highly profitable business. Do yourself a favor and stop avoiding proactive tax-planning guidance so that you can keep more of your hard-earned money.