IRA options for self employed : Solo 401k vs SEP IRA

[InvisibleCrow]

I need advice on tax structure that would allow me to contribute to pre tax IRA account.   I have 2 sources of income. 

1) Capital Gains from real estate and trading

2) Consulting Business where I'm the sole proprietor and don't expect to have any other employees in forseable future.  Expected income in low 6 figures for current year. Not registered as a separate entity or have a unique tax id.   I'm making estimated quarterly tax payments. 

I can comfortably sustain my living expenses from #1.  The goal is to put as much income from the consulting business (#2 above) into IRA to lower taxable income.  As I understand, I can set up a SEP IRA or Solo 401k. 

Given my situation, which of the two IRA accounts is more suitable?  Does one have higher contribution limits than other? My preference is keep things as simple as possible so would like to avoid setting up an S Corp, report as employee and deal with payroll etc.  

[dmertz]

A solo 401(k) will permit a greater contribution than will a SEP IRA because a solo 401(k) permits employee elective deferrals in addition to an employer contribution while a SEP IRA permits only an employer contribution.  (If you make no elective deferrals to the solo 401(k), the maximum permissible employer contribution to the solo 401(k) is the same as the maximum permissible SEP IRA contribution.)  However, a solo 401(k) requires more effort to set up and maintain than a SEP plan; a SEP plan only requires establishment of the SEP IRA account and the completion of the SEP plan contribution agreement, often just IRS Form 5305-SEP, and there are no annual reporting requirements as there are with a solo 401(k) when the solo 401(k) year-end balance exceeds $250,000 or is the final year of the plan.  Still, if your intention is to contribute the maximum possible, a solo 401(k) is probably the way to go.

I suggest reading IRS Pub 560:

https://www.irs.gov/pub/irs-pdf/p560.pdf

With regard to reducing taxable income, keep in mind that deductible contributions mean only deferring the taxable income.  Eventually it will be taxed, potentially at a higher rate than you might pay now.  It might be advantageous to make some or all of your contributions be Roth contributions so that, once you meet the requirements for qualified distributions, distributions from the Roth account will be tax free instead of taxable the way they would be from a traditional SEP IRA or solo 401(k).  You'll enjoy tax-free investment growth instead of tax-deferred growth, but of course you'll be paying taxes up front on the amounts contributed.  Still, since some of your other income comes as income subject to taxation at long-term taxable gains, you might not want to push the long-term gains from the 0% to 15% bracket if that's what would happen if you don't make deductible retirement contributions.

You'll also want to take into account any regular personal IRA contributions might be possible if you have net earnings left over after your net earnings are reduced by the amount of your deductible retirement contributions.