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  • 1099 income, accept individually or create LLC (or similar)

    I am employed by a hospital system and max out my 401K, including catch up provision as I am in my mid 50s. Also have a NQDCP (part of a rabbi trust) that I max out 30K up to age 54 and 50K 55 and above. My wife is a homemaker. My W2 income through primary employment after 401K and NQDCP is usually 350-425K. Also have side gig speaking for pharma co and reviewing charts for a review company both of which are paid by 1099 to me directly. This income could be 6K-30K per year. Is it beneficial for me to set up a business structure for the 1099 income with a solo 401K? Issues include:
    1. Costs of setting up business relative to the 1099 income
    2. Putting away more tax deferred money when tax rates are likely going up in future or is a reasonable Solo Roth 401K allowed/available? Mega Back Door Roth if I have a better than average 1099 income year?
    3. Would this allow me to hire my 14 year old daughter to create W2 income for her and then I can set up a custodial Roth IRA for her?
    4. If it looks appropriate to create a business, then is an LLC the best entity?
    5. Does my W2 income mean that I cannot utilize the 199a QBI deduction for the 1099 income?
    6. Anything else I have missed?
    Thank you!

  • #2
    I don't see any reason to use an LLC for this income unless it would provide some kind of liability protection for you. Whether you have an LLC or remain a sole proprietor, you will be able to take the same tax deductions, qualify for QBI deduction on the 1099 income, contribute to a solo-k, etc. Mega BD Roth might be an option, but you have to consider the cost of setting one up+ongoing reporting. Not sure it w/b feasible at that $6k but maybe at $30k.

    If you need a home office to do the chart reviews, be sure to set up appropriately (don't use the guest bedroom, etc.)
    Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      To clarify the QBI deduction: My W-2 income has no effect on whether I am eligible for the deduction on my 1099 income, correct?

      2nd question: As long as I have no employees, I can use my social security number for the sole proprietor tax ID number (which I am already using currently for this 1099 income anyway so does not create a new risk). It appears that if I keep it this simple (using my name and SS#), Missouri doesn't requires formal registration of the business. Does this mean I am already eligible for the QBI deduction or I need to more formally set up the sole proprietorship?

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      • #4
        First, the QBI deduction phaseout ($326,600 - $426,600) is based on "taxable" income. It does​​​n't matter whether it comes from W-2, self-employment and/or any other income. Only the net amount (AGI - standard or itemized deductions).

        If you have legitimate business work tasks for your daughter to do. You can pay her a far market value (FMV) wage for the actual number of work hours. You definitely do NOT want an S-Corp because of the level of your W-2 wages. Additionally, as a self-employed individual no FICA is required if your child is < 18 and no FUTA if your child is < 21.

        Make sure you do not use Vanguard for your one-participant 401k. They do not allow employee eligibility restrictions. You will want elect to restrict employees < age 21 and/or < 1,000 hours per year. Effective three years after 1/1/2021 (1/1/2024), the hours/year will reduce to 500/year if over three years.
        Last edited by spiritrider; 08-15-2020, 06:59 AM.

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        • #5
          Originally posted by notanotherusername View Post

          2nd question: As long as I have no employees, I can use my social security number for the sole proprietor tax ID number (which I am already using currently for this 1099 income anyway so does not create a new risk). It appears that if I keep it this simple (using my name and SS#), Missouri doesn't requires formal registration of the business. Does this mean I am already eligible for the QBI deduction or I need to more formally set up the sole proprietorship?
          Correct, you dnh to formally register with MO (or any state) for a sole proprietorship. Check with your city/county reg's to see if you need to register for a business license.
          Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            Spiritrider: I believe there is a typo in your 2nd sentence. I assume you intended to say it doesn't matter, correct? This year we have extra "income" due to converting my wife's SEP-IRA to a Roth so I think it's clear that I won't be eligible for the QBI this year with a taxable income that will be just a little north of 426,600 even before the side gig 1099 income.

            So far for 2020, I have been been paid approximately 16-20K of 1099 income and the W9 stated my name and my social security number. If I am a sole proprietor using my name and my social security number (and therefore no need to register with the state), what would be considered my start date? Could I use the 1099 income from earlier this year to justify funding a solo 401k for this year?

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            • #7
              Originally posted by notanotherusername View Post
              Spiritrider: I believe there is a typo in your 2nd sentence. I assume you intended to say it doesn't matter, correct? This year we have extra "income" due to converting my wife's SEP-IRA to a Roth so I think it's clear that I won't be eligible for the QBI this year with a taxable income that will be just a little north of 426,600 even before the side gig 1099 income.

              So far for 2020, I have been been paid approximately 16-20K of 1099 income and the W9 stated my name and my social security number. If I am a sole proprietor using my name and my social security number (and therefore no need to register with the state), what would be considered my start date? Could I use the 1099 income from earlier this year to justify funding a solo 401k for this year?
              This might be a good year to consider a strategically-calculated DAF contribution (assuming you are charitably inclined).
              Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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              • #8
                Originally posted by notanotherusername View Post
                Spiritrider: I believe there is a typo in your 2nd sentence. I assume you intended to say it doesn't matter, correct?
                Yup, edited

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                • #9
                  Originally posted by jfoxcpacfp View Post

                  This might be a good year to consider a strategically-calculated DAF contribution (assuming you are charitably inclined).
                  Agree entirely. We did set up our first DAF this year and funded with appreciated ETFs from our taxable account.

                  Is anyone able to address the question about start date of a sole proprietorship for 1099 income that could be utilized to fund a 401K? Since I don't have to register with the state as the proprietorship will be using my name and social security number, is there a formal start date to the sole proprietorship? The W9 I previously filled out used the individual/sole proprietor check box. I have already received 14K so far this year in 1099 payments. Can this money be used to fund a solo 401K? As for my 401K associated with my W2 income, by then end of the year I will have contributed 26K (I am in mid 50s) to the employer provided 401K and will have an approx $4200 match.

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                  • #10
                    A sole proprietor's income is all deemed to have occurred on the last day of the tax year.

                    Prior to 2020, you could adopt a 401k anytime before 12/31 and make the effective date 1/1 of the same year. You also had until 12/31 to make employee deferral election.

                    Starting in 2020 you now have until your tax filing deadline including extensions to adopt a 401k. I have not heard any clarification on the effective date or the employee deferral election deadline.

                    To be safe use the rules prior to 2020 and as long as you set the effective date to 1/1. You have until your tax filing deadline including extensions to make contributions. This is true even if the self-employment income occured before the 401k was adopted.

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                    • #11
                      Thank you Spiritrider.

                      My plan for this year will be to have no employees and start a solo 401K with the 1099 income. To maximize the 401K contribution to include most, if not all of the 1099 income, do I need to pay myself W2 income?

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                      • #12
                        I think I found the answer to my question. Since I already have maxed out the employee contribution and catch up provision at the 401K associated with my W2 income (19,500 plus 6,500 catch up plus approx 4,200 employer match), I cannot do any additional employee contribution for the solo 401K. This brings up 2 questions:
                        1. In calculating the amount I can contribute to the solo 401K from the "employer" side, I understand the employer's side of payroll taxes is taken into account. Is this affected by my W2 earnings being above the social security income cap?
                        2. I am using the entity of a sole proprietorship in order to contribute to a solo 401K. Am I taking on the burden of paying the employer's end of FICA to do this (which of course makes it much less attractive)?

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                        • #13
                          1. Your net earnings from self-employment (self-employed earned income) = business profit - 1/2 SE tax. If you have have exceeded the Social Security (SS) maximum taxable earnings (MTE). The SE tax will only be the 2.9% Medicare component.
                          2. If you were using an S-Corp it would be much worse.
                            1. A sole proprietor pays both the employer and employee share, but does not pay SS taxes once the SS MTE is reached.
                            2. On the other hand, an S-Corp pays the employer share and the 2% shareholder-employee pays the employee share. The SS taxes must be paid even if the SS MTE is reached. While the 2% shareholder-employee's excess SS taxes can be claimed on their tax return. The excess employer's SS taxes can not be recovered.
                          P.S. In case it is not clear. If the the SS MTE is reached with primary W-2 SS wages. An S-Corp should almost never be used for a moonlighting business. An S-Corp will pay more in net FICA taxes than you would pay as a sole proprietor.
                          Last edited by spiritrider; 08-18-2020, 05:10 AM.

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                          • #14
                            Would the calculation be as follows:
                            Round off my current 1099 income to $15,000 for ease of calculation
                            No expenses as all 1099 income was for local speaking engagements and mileage was reimbursed so income still at $15,000

                            Subtract 1/2 SE tax: 15,000 x 0.0765 = $1147.5
                            Equals: 15,000 - 1147.5 = $13.852.5
                            Take 25% for "employer" contribution to solo 401K = $3,463.12

                            Is this correct or would it be 0.0145 for half of SE tax in which case:

                            Subtract 1/2 SE tax: 15,000 x 0.0145 = $217.5
                            Equals: 15,000 - 217.50 = $14,782.5
                            Take 25% for "employer" contribution to solo 401K = $3,695.62

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                            • #15
                              [QUOTE=spiritrider;n222125]First, the QBI deduction phaseout ($326,600 - $426,600) is based on "taxable" income. It does​​​n't matter whether it comes from W-2, self-employment and/or any other income. Only the net amount (AGI - standard or itemized deductions).

                              I would like to get a clarification regarding which income may be subject to an income limit for the 199a deduction. Have been discussing with Jim (WCI) under his post "A New Reason to Use the Mega Backdoor Roth IRA" originally posted on 5/13/19 with our replies from last 2 days. My question for him was related to his ability to utilize the 199a deduction for income within the WCI business when he is otherwise in the 37% tax bracket (placing his taxable income > 600K), while it does not appear at first glance that I would be able to use the 199a deduction for my 1099 income due to my taxable income being above 426,600 although will be less than 600K. My W2 income would be clinical physician RVU generating work, while my 1099 income (sole proprietor, perhaps 15-25K this year) would be for speaking for pharma (all income likely coming from 1 pharma company). I think that the difference may have something to do with WCI not being considered a service business that is subject to an income cap (is this true? Jim is taking the 199a deduction). Since my 1099 income is generated from speaking for pharma, will this income be subject to the taxable income cap?

                              Thanks in advance.

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