401k - Profit Sharing Plan
If you are a small business owner, the Internal Revenue Service (IRS) rules enable you to make significant contributions to your own 401k retirement plan when it is combined with a Profit Sharing Retirement Plan.
Here's how it all works. First of all, your small business must be generating earned income. Earned income from an unincorporated business is the net earned profits from that business. Your earned income from a corporation would be your W-2 salary from the corporation. The corporation can be either a C or S corporation.
The main difference between these two types of corporations is that C corporations pay income tax on their profits; S corporation profits are taxed on the individual shareholders personal income tax returns. Sub-Chapter S Corporation is another name for a S corporation.
Contribution Limits
The 401k feature of your retirement plan enables you to defer up to $16,500 of your salary or earnings in 2009. If you are age 50 or older in 2009, you can defer up to $22,000 in 2009. The 401k and the Profit Sharing contribution limits for 2010 have now been released and they remain unchanged because the cost-of-living index has not increased.
The profit sharing feature of your retirement plan allows you to make an additional contribution of up to 25% of your salary or earnings. The total amount of both the 401k deferrals and the profit sharing contributions are limited to a maximum of $49,000 in 2009. If you are age 50 or older in 2009, the total maximum is $54,500 for 2009. These limits are the same for 2010 because the cost-of-living index has not increased.
A great advantage of this 401k - Profit Sharing Plan is that you are not locked into contributing a certain amount or percentage every year. If your income has decreased in a certain year, you have the flexibility of lowering your 401k - Profit Sharing contribution. You can vary the profit sharing percentage from 25% of your salary or earnings to all the way down to zero%. It works the same with the 401k salary or earnings deferral. You can have a maximum 401k deferral of either $16,500 ($22,000 age 50) or all the way down to a zero deferral.
Income Tax Advantages
A 401k - Profit Sharing plan has significant income tax advantages; plus it forces you to save for your retirement. You can enjoy these income tax benefits no matter what is the size of your earnings. If you are a sole proprietor, your 401k - Profit Sharing contribution becomes a tax deduction on the first page of your Form 1040 Individual Federal Income Tax Return. If your small business is a corporation the 401k - Profit Sharing contribution is deducted as a business expense on either your Form 1120 or Form 1120-S Federal Corporation Income Tax Return.
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Tax Advantages Of A 401k - Profit Sharing Plan
The tax savings for a 401k - Profit Sharing deduction will vary because of an individual's personal tax situation. The tax savings will be somewhere between 10% and 35% of the deduction. For instance, if you were in the 25% tax bracket, a 401k - profit sharing deduction of $30,000 would result in a federal income tax savings of $7,500. Depending upon the state where you reside, there also could be additional state income tax savings.
The tax advantages are maximized if your small business has no employees except either you, your spouse or other co-owners. The business can be either a sole proprietorship, a corporation or a partnership. If your small business has other employees, the financial advantages are lessened because the IRS requires your business to make a profit sharing contribution on behalf of those employees.
If your small business is a C type corporation, the corporate income tax savings from your retirement plan deduction will generally be between 15% -39% of the deduction.
You can establish your 401k - Profit Sharing plan through a financial institution such as a mutual fund company, a securities brokerage firm, a bank, or an insurance company. There are also 401k retirement plan specialists who can design and customize your retirement plan.
