Is it common to drastically reduce federal income taxes like this?

[kater832]

My wife and I file jointly, but we each have separate businesses as sole proprietors (Schedule C).

This year, our combined net income, after business expenses, was around $124K.
We contributed a total of about $66K to our Solo 401(k) accounts, plus $14K to our Roth IRA.

As a result, our federal income tax owed is only $1700. Of course, this doesn’t include self-employment taxes, which are still a big chunk of money.

Of course, our personal living expenses are greater than our remaining income after these retirement contributions. We used cash saved from previous years to fund the contributions, with the primary goal of reducing our tax bill.

I’m not concerned about an audit, since all our numbers and expenses are legit.
I’m just genuinely curious—do other folks out there use strategies like this to significantly reduce their federal income tax bill?

Thanks!

[dmertz]

There is nothing impermissible about making maximum permissible deductible contributions to a solo 401(k).  It's a common way to reduce present taxable income with the understanding that this deferred income and the gains on it will eventually be taxable as ordinary income when distributed.

Keep in mind that distributions are taxable as ordinary income, so it generally makes sense to defer the taxable income only if you expect your marginal tax rate when eventually distributed to be lower.  For those with good saving habits, that's often not the case, so someone presently in a low tax bracket such as yourselves might be better off deferring less income now and instead investing that money in capital investments where gains can enjoy taxation at long-term capital gains rates instead of at future ordinary income tax rates.  Still, you might want to defer enough income to keep you in the AGI range that allows the maximum Retirement Savings Contributions Credit, which might preclude you from topping out your current tax bracket.  With AGI below $46,000 for 2024, the retirement contributions that you made would typically make each of you eligible for a $1,000 tax credit on Form 8880.  (If slightly above that AGI, it might make sense for some of the Roth IRA contribution(s) to be traditional IRA contribution(s) instead.)

(Note that there is no our Roth IRA.  Roth IRAs are not joint accounts, they are owned by a single individual.)

[Opus 17]

Here's my concern, which @dmertz touched upon, but I want to make it more explicit.

You took money that was not taxable and made it taxable.  Suppose you had $10,000 in a savings account, and you are looking at a decision to either contribute $56K to the 401K and live off your present income and not touch the savings; or contribute $66K to the 401k and withdraw the $10,000 for living expenses.

If you left the $10,000 in the savings account until you retired, you could withdraw it tax-free.  You would of course pay tax on the interest each year, but the principal balance is not taxed when you withdraw it.  Or, if the money was invested in mutual funds outside of an IRA or 401k, you would pay yearly tax on some dividends, and you would pay tax on capital gains when you withdraw in retirement at the lower capital gains rate, and the principal would still be tax-free.   By taking the money out of savings and putting it into the 401k, you reduced your present taxes, and you eliminate the annual taxes on the interest, but that $10,000 now becomes taxable when you withdraw in retirement. 

I can't take the time to figure out which is a better deal (and I'm not sure I have the skills), but if this situation comes up again, you may want to discuss with a financial planner, whether you should max out the 401k if it requires withdrawing from savings or cashing in investments that might have a lower tax rate when you retire.