Businesses Owners and Self-Employed: You Can Still Reduce Tax Liabilities For Tax Year 2016
Most of the big opportunities for business tax deductions slammed shut as of January 31st, but not all of them! If you want to send less money to the IRS this year, and keep more of your business’s money for the benefit of you and your employees, there are still some things you can do.
Make SEP IRA Contributions
If you are sitting on some cash, you may want to make contributions to a Simplified Employee Pension plan. If you don’t have a plan established already, it’s not too late to get one set up in time to benefit you before you file your last tax return for tax year 2016. Unlike 401(k) plans, which must be established and funded by the end of the calendar year for deductions to count for that tax year, SEP IRAs give individuals and employers some extra flexibility: Employers have until their tax filing deadline (including extensions) to establish the plan, make contributions, or both.
For those of you operating as self-employed/sole proprietors or running S corporations, you have until April 15th of 2017 to make SEP IRA contributions for tax year 2016. For employers filing as corporations, you have until your first filing deadline of 2017 – the Q4 filing date for tax year 2016 – to establish or contribute to a SEP or both.
For SEP IRAs, the employer cannot pick and choose which employees qualify for contributions. Employer contribution percentages must be equal for all employees eligible for the plan.
Employees don’t make elective deferrals under a SEP plan, and there are no catch-up provisions for employees over the age of 50 as there are for IRAs and 401(k) plans. All contributions must be employer contributions. That is, employees cannot contribute to their employer’s plan on their own, and every eligible employee must receive the same percentage of compensation.
The maximum allowable contribution for any given employee cannot exceed either 25 percent of total compensation, or $53,000 – whichever is less – for tax year 2016.
Special Considerations for Self-Employed SEP IRA Owners
If you are self-employed, the math is a little different. This is because you must account for the effect of self-employment taxes on your taxable income. For self-employed individuals, your maximum contribution works out to 18.587045 percent of your total compensation for the year, instead of 25 percent – again, up to a cap of $53,000 for tax year 2016.
Calculating Self-Employed Compensation
For the purposes of calculating allowable SEP IRA contributions, base your total compensation on net profits for the year, minus one-half of your Social Security tax liability, and minus the amount of your SEP contribution.
This provision may apply if you are a sole proprietor, or employed under a closely-held LLC structure.
Limits for 2017
If you establish a SEP IRA for 2017, you can also begin making contributions for tax year 2017. This year, contribution limits are slightly higher than they were for tax year 2016. You can contribute a maximum of 25 percent of each eligible employee’s compensation (18.587045 percent for self-employed individuals) up to an overall per employee cap of $54,000.
The optimal strategy, however, is to make available contributions for tax year 2016 first, and exhaust them before you begin making 2017 contributions.
Contributions Are Voluntary
There is no obligation to continue making SEP contributions. Unlike traditional, defined benefit pension plans that require ongoing funding, funding a SEP IRA is completely voluntary. If business conditions do not permit you from making a large SEP IRA contribution for your employees, you don’t have to. But if you do make a SEP contribution, you must contribute an equal percentage of compensation to the account of each eligible employee – including employees over age 70½.
Contributions are not taxable to employees, but are fully deductible to the business/employer. Report all contributions on an IRS Form 5498 for the year the funds are actually deposited into the account.
Make SIMPLE IRA Contributions
Like the SEP IRA, the SIMPLE IRA – an alternative defined contribution plan for companies with fewer than 100 employees – also allows you to make contributions for employees through your tax-filing deadline. That is, you can still make contributions even after the end of the tax year – provided you have already established the plan. At this point, this provision only applies to matching and non-elective contributions, or employer contributions, for tax year 2016. However, if you haven’t already established the plan, you can’t make 2016 contributions. You may still be able to establish a SEP plan, however, if you’re eligible, and make contributions for tax year 2017.
You must make matching and non-elective contributions to the financial institution maintaining the SIMPLE IRA no later than the due date for filing your business’s income tax return, including extensions, for the taxable year that includes the last day of the calendar year for which you made the contributions. If you extend your tax return, then you have until the end of that extension period to deposit contributions, regardless of when you file the tax return.
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