I'm freelance and not incorporated, so can only contribute the rather lower limit to an IRA as an individual. My income is a mix of 1099 and W2, and I had a large amount of medical costs this year.
How can I run the numbers to see if incorporating and creating a SEP IRA would be worth it?
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An LLC, Limited Liability Company, is a state legal entity, not a tax entity. If you want to be taxed as a corporation, you will need to file an entity election form with the IRS, otherwise you will default to either a sole proprietor - if a single member LLC, or a partnership - if a multi-member LLC.
Basically, the tax savings will be on employment taxes - Social Security and Medicare, and on the deduction of the SEP IRA contributions by the company.
There are many considerations when choosing a tax entity. Corporations are subject to income tax, currently at 21% of their profit, so you may end up paying tax on money twice. Once at the corporate level and then again if you take that money in a later year as compensation or dividends from the corporation.
People sometimes choose to make an S-election. This allows for the income and expenses to "flow-through" to the shareholders. The income doesn't get taxed at the corporate level, only the shareholder level. Once the income tax is paid, the distribution can be made at a later date without paying income tax on it again. However, shareholders participating in the operation of the company are expected to take a reasonable salary, so there will be a certain amount of employment tax - social security and Medicare - that will have to be paid. This is usually a lower amount than taking it all as self-employment income as a sole-proprietor.
Here are some resources that may be worthwhile reviewing before making a decision:
Calculating your own Retirement Contribution
Limited Liability Companies and Taxes
IRS entity declaration form for LLCs
What you need to know about SEP IRAs
Hope this helps!
Cindy
Hi, Cree_T,
As background, the IRS considers an LLC to be a disregarded entity (which means they pretend it doesn't exist and they look past it to how you are operating). This TurboTax article does a good job of explaining various tax reporting option for an LLC that has not made elections to be taxed otherwise. This IRS page also talks to the various types of business structures
As an LLC, you can elect to be taxed as an S-Corp.. The aforementioned linked article discusses the S-Corp, including some of the tax benefits. It is also possible to elect to be taxed as a C-Corp, but that is usually more challenging to administer and isn't the usual pathway elected by LLCs.
Hope this helps.
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Karen
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