As we begin tax season 2022, small business owners are likely looking for ways to lower their tax bills for 2021. While we all know the world was crazy in 2021, many business owners enjoyed record profits that could lead to record tax bills. One of the options still available to lower last year’s taxes is opening and/or funding a small business retirement plan. If you are a small business owner facing a large tax bill, you may be wondering whether you still have time to open a new retirement plan for your business (or self-employment income) for 2021. The exact answer for your situation will likely be, “It depends.” Keep reading to find out if there is an account that will benefit you.
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.
Can you still open a SEP-IRA for 2021?
Generally, the SEP-IRA is the easiest small business retirement plan to open. You can still open and fund a SEP-IRA for 2021. 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 $58,000, whichever is smaller. Many business owners will be able to contribute more to a solo 401(k) than a SEP-IRA.
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. The good news is going forward, you indeed can set up a solo 401(k) up until the due date for the corporate tax returns, the same as for SEP-IRAs. But there are limits to contributions when opening a solo 401(k) after the tax year has ended.
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 election by 12/31/2021 (for the tax year 2021).
Without 2021 elective deferrals, it will be harder to get the maximum amount allowed into a solo 401(k) for 2021. The maximum 2021 contribution for a new solo plan adopted in 2022 is $58,000. If the new 401(k) plan had been established in 2021, the contribution limit for owners who are 50 or older would have been $64,500 if the $6,500 elective deferral catch-up contribution had been used.
Cash Balance Plan Establishment Deadline
For high-income business owners, great news was hidden in the SECURE Act regarding cash balance plans. Like the solo 401(k), the deadline to establish a cash balance plan has been extended to your tax-filing deadline, including extension. Unlike the solo 401(k), all contributions to a cash balance plan are from the employer.
In plain English, this means you can set up and fully fund a cash balance plan in 2022 for 2021. 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).
Talk with your tax-planning expert and financial planner to see which small business plan makes the most sense for your retirement and tax needs.