Lowering Your Tax Bill
Pay Yourself Instead of the IRS
By Marie Poliseno
If you are like most dog professionals that I work with, you probably transitioned from being a full time employee to being self-employed. One of the many benefits of working for others is the ability to contribute to a 401K. Unfortunately, as we become our own boss, contributions to a Retirement Plan often fall to the wayside.
You’re likely aware of the benefits of saving for your own retirement, but you may not realize the positive, short–term impact on your taxes each and every year that you make a contribution to a qualified plan. It can add up.
Making Retirement Plan Savings Contributions
If given the opportunity, would you rather pay yourself or the IRS thousands of dollars? Cash flow is a common problem for dog pros, especially when starting out, and my clients often tell me they’ll think about saving for retirement when things get rolling and start looking up. But you don’t really save money that way. You just end up giving it to the IRS. Budgeting is essential, especially when cash flow is limited. But knowing how to spend those budgeted dollars is even more important.
Did you know single individuals making less than $17,750 are allowed to take a credit on their taxes of up to $1,000 if they contribute to a Retirement Savings Plan? So in addition to the contribution being tax deductible (depending upon the plan), the government will pay you up to $1,000 to put something away toward your own retirement.
Contributions can be made to traditional IRAs, SIMPLE plans, or SEP IRAs. Each type of plan has specific criteria and maximums for how much can be contributed, but in all cases, they provide an effective means for paying yourself what you would otherwise be paying the government.
Here’s an example: Let’s say you earn $17,750 per year, are single, and under the age of 50. Your accountant informs you that you owe a whopping $3,118 in both income and self-employment taxes. If you contribute $2,000 to a qualified Retirement Plan before the April 15th deadline, you will reduce your tax burden by $1,200 (your tax will be reduced by $200 as you are in the 10% tax bracket and you will receive $1,000 as a Retirement Saver’s tax Credit.) So now you only owe the IRS $1,918, and you put away $2,000 for yourself!
The advantages for those making more than $17,750 are even greater. While the Retirement Savings Credit is not available for single individuals making more than $29,500 (it’s phased out based upon the income level of the individual and completely goes away at $29,500), contributions to a SEP IRA can be as much as $52,000. That may seem unrealistic, but remember that’s the maximum amount, you can contribute less. SIMPLE IRAs have another advantage. Your company can match up to 3% of the contribution, which creates another tax deduction that not only reduces your income tax, but your self-employment tax as well.
Getting Started
Choosing which plan is right for you is not all that difficult, but there are rules to be aware of before setting one up. Working with a tax professional or financial advisor can be helpful in selecting a plan and reviewing the investment options, but it’s not necessary.
Setting up your own plan is easy. Just contact a brokerage firm or bank who will provide you the application. IRAs and SEP IRAs can be set up almost immediately. SIMPLE plans must be set up by October 1st in order to make contributions the following year, so plan ahead if a SIMPLE plan is your choice. If funds are limited right now, you might consider setting up an IRA to start, which can later be rolled over into a plan with higher contribution limits. The important thing is to get started!
Of course, the effect of retirement plan contributions vary with the type of plan, the amount you contribute, and your earnings, but each has their own unique way of allowing you to manage your tax liability.
Conclusion
Contributing to a qualified retirement plan is one of the easiest ways to reduce your tax burden while building a little nest egg for yourself. Budgeting some of your hard-earned dollars to pay yourself instead of the IRS—while also planning for your future—is one of the most effective tax strategies you can have in your financial toolkit.
Marie Poliseno is the Managing Partner of Dollars & Scents Accounting Services. She is a Certified Public Accountant (CPA) as well as a professional dog trainer (CPDT-KA) and honors graduate of the SFSPCA Academy for Dog Trainers (CC). To work with Marie on your financial and tax matters, e-mail [email protected] or visit www.dog-pro-cpa.com to learn more about her services.