Last Minute Year-End Retirement Deductions for Small Business Owners

You still have time before December 31 to take steps to help you fund your retirement. Here are four strategies that might help.

Establish Your 2020 Retirement Plan

Do you have your employer’s retirement plan in place? If not, and you have some cash on hand, get that retirement plan in place now so you can obtain a tax deduction for 2020. For most defined contribution plans, you (the owner-employee) are both the employee and the employer, whether you operate as a corporation or a proprietorship. That is a good thing because you can make both the employer and the employee contributions, allowing you to put a good chunk of money away.

Your plan document defines when you can make employee and employer contributions that will result in 2020 tax deductions. Make sure you know exactly when to make those deductions.

Claim the new, improved retirement plan start-up tax credit of up to $15,000

First, you need to answer two questions:

  • Are you the solo worker in your business?
  • Is your retirement plan in place as you read this?

If the answer is no to both questions, consider establishing a new qualified retirement plan (such as a profit-sharing plan, 401(k) plan, or a defined pension plan), a SIMPLE IRA plan, or a SEP to qualify for a non-refundable tax credit that is the greater of:

  • $500, or
  • The lessor of (a) $250 multiplied by the number of you non-highly compensated employees who are eligible to participate in the plan, or (b) $5,000

The credit is based on your “qualified start-up costs,” which are ordinary and necessary expenses paid or incurred in connection with:

  • Establishment of administration of an eligible employer plan, or
  • Retirement-related education or employees with respect to the plan

The credit applies to year of the start-up and for the next two years (capped at $5,000 a year or $15,000 maximum). You may deduct costs in excess of the tax credit as ordinary and necessary expenses.

Note that the employer with no employees is not eligible for the small business plan start-up credit.

Claim the new automatic enrollment $500 tax credit for each of three years ($1,500 total)

The SECURE Act added a nonrefundable credit of $500 per year for up to three years beginning in 2020 or later in which you, as an eligible small employer, include an automatic contribution arrangement in a 401(k) or SIMPLE plan. The $500 auto contribution tax credit is in addition to the start-up credit and can apply to both newly created and existing retirement plans. Further, you do not have to spend any money to trigger the credit. You just need to add the auto-enrollment feature.

As with the start-up credit above, you are an employer eligible for the credit, for the preceding year if:

  • You had no more than 100 employees, each with compensation of $5,000 or more, and
  • Your plan had at least one employee eligible to participate who is not a highly compensated employee

A solo business operator with no employees is not eligible for the automatic enrollment credit.

Convert to a Roth IRA

Consider converting your 401(k) or traditional IRA to a Roth IRA. If you make good money on your IRA investments and will not need your IRA money during the next five years, the Roth IRA can produce financial results far superior to the traditional retirement plan. Note that you will need to determine how much tax you will have to pay to convert your existing plan to an IRA, and be sure you have enough cash on hand to do so.

Here are four reasons you should consider converting your retirement plan to a Roth IRA:

  • You can withdraw the monies you put into the Roth IRA at any time, both tax- and penalty-free, because you have invested previously taxed money into the account
  • You can withdraw the money you converted from the traditional plan to the Roth IRA at any time, tax-free. (If you make that conversion withdrawal within five years, however, you pay a 10 percent penalty.)
  • When you have your money in a Roth IRA, you pay no tax on qualified withdrawals, which are distributions taken after age 59 ½, provided you have had your Roth IRA in place for at least five years
  • Unlike a traditional IRA, you do not have to receive required minimum distributions from a Roth IRA when you reach age 72

Again, make sure you have enough cash on hand to pay the tax on the conversion to a Roth IRA, and do not invade your existing 401(k) or traditional IRA to pay the taxes as that is likely to trigger the double whammy of paying conversion taxes and the 10 percent penalty on the invasion.