Why do people become business owners? Common answers we often hear from our clients is so we can follow our dream and do what we love. We saw a need or a different way of doing things. It allowed intellectual creativity and flexibility in my work schedule. Fine-tuning the culmination of these factors will bring success, and success is often followed by an increase in wealth-building potential.
We often forget that on this path to success and wealth-building, we are accompanied by a silent investor, the IRS. In the United States, a marginal tax rate system is utilized, which means that the amount of additional tax paid for every additional dollar earned as income is based on it’s respective bracket. The highest marginal tax bracket for 2022 is 37% for single filers making $539,901 or more and $647,851 or more for married filing jointly. Add in CA, state tax, which is at least 10.3% starting at $312,687 for single filers and $625,373 for married filing jointly. Don’t forget the cherry-on-top, which is the 3.8% Obamacare Medicare Surtax. Unfortunately, this level of success means you have at least a 51.1% silent investor in your business and any additional dollar of income earned.
Fortunately, as business owners, you have some creativity available for deferring away earned income. The IRS allows business owners to establish qualified retirement plans to contribute towards retirement. These contributions are tax-deferred the year the contribution is made and taxed as ordinary income when distributions are taken during your retirement years.
Your Defined Contribution (DC) plans (401(K)/Profit Sharing) allows contributions up to $61,000 and if you’re age 50+, an additional $6,500 catch-up contribution.
You can also stack a Defined Benefit (DB) plan on top of your DC plan. These DB plans come in two flavors, a traditional Defined Benefit or a Cash Balance plan. The contributions on this end are based on three main factors: your age, amount of earned income, and years of service in the company. A traditional Defined Benefit will allow for higher contributions and a Cash Balance will allow for more flexibility in your yearly contribution. Ex.: Age 50, $300,000 of business compensation, and 5 years of service has a Level Deductible Contribution of $229,416 and a Maximum Deductible Contribution of $344,1243.
If you have discretionary earnings, why pay your silent investor 50% of those earnings today? Why not defer those earnings, allow them to grow tax-deferred, and then pay it spread across your entire retirement?
If you’re a specified service business, establishing qualified plans may help reduce earned income down to $340,100 for married fling joint and $170,050 for single filers for 2022, where you’ll be eligible for the 199A deduction, which is an additional 20% tax deduction on QBI (Qualified Business Income).
Due to the SECURE Act, you still have until corporate extension deadline of Sept. 15, 2022 to make contributions for 2021.
You became a business owner to take control of your life! We would love to have a complimentary consultation with you to see if we can help you take control of your assets.
Phil Kang is a Registered Principal and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 5280 CARROLL CANYON ROAD, SUITE 300, SAN DIEGO CA, 92121, 619-6846400. Securities products and advisory services offered through PAS, member FINRA, SIPC. General Agent of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Henry Chau is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. PAS is a wholly owned subsidiary of Guardian. WESTPAC WEALTH PARTNERS is not an affiliate or subsidiary of PAS or Guardian. Insurance products offered through WestPac Wealth Partners and Insurance Services, LLC, a DBA of WestPac Wealth Partners, LLC. Kang CA Insurance License #0G18874 | Chau CA Insurance License #0I21767 | 2022-140061 Exp. 06/24 | Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
By Henry Chau, CPWA®, WestPac Wealth Partners