Monay, Monay Mooooonay…. MONAY!
Alright!!!… here we go! I’m gonna pump up this blog post with about a bazillion exclamation points because the subject can bring such an “ughhhh, that topic again” feeling to the party. We don’t want that. What is the subject I speak of? Taxes. Wait… no… dim the lights, cue the music, explode confetti cannons. What are we talking about today? “TAXES!!!!!!” BOOM!!! Yah, there we go!
So, you’re a small business owner, (or maybe not, but you have a small obsession with taxes – which is weird) and you’re thinking “Man, I’ve got to prepare an ugly amount of paperwork, receipts, and numbers in the next few months, just so I can pay out Mr. Government a fatty check”. (My favorite part of taxes is writing checks where the written amount doesn’t even fit on the line). That check is your reward for all that hard work and record keeping. As my sister would say, “Yayyyy!” Errr. Maybe, “nayyyy”.
Now, here comes my deal. It’s incredible! It’s fantastical! It’s just for YOU! For a limited time only, at the low low price of $9.99…… haha no… just kidding, this is not an infomercial.
What I am about to share with you is a very basic strategy to keeping a nice chunk of your profits in your pocket instead of giving them to the man upstairs. People who work for corporations have the opportunity to take advantage of 401K’s that literally give people money, for saving money. But what about us lowly self employed? Are we left to just shell out, without any opportunities of tax advantageous investments? No. We have something called a SEP IRA. “SEP… What?” You say.
Now… before I begin. I did not learn this on my own. I learned this from my accountant last year. I am not a tax accountant, I don’t want to be a tax accountant. I am really just speaking from my personal experience, with the hope that you the reader, get knocked upside the head and make a move after reading. This is purely my own interpretation of how it all went down. So please use the following as a flame to spark your own inquisition. Please… Reach out to someone who really knows what they are talking about! I can’t be held liable people!
A SEP IRA is a tax deferred investment account that allows you to put money into it, before its taxed. Yes! This means you don’t pay taxes on it! Well, not right now anyways. NO TAXES!!!! Have I caught your attention? This is like the headliner to my show!!! BOOM! More confetti!!! You make money, put it in a SEP IRA, and you get to use that investment as a MONDO write off from your income. Ohh, you’re so busy keeping those receipts for coffee… right. Well how about writing yourself a receipt for something on the order of $10,000? Now, dat’s a LOT of coffee! IRAs also mean long term growth. Go look them up and you’ll see the graphs go up and to the right at an exponential value with time. That’s a good direction. This is like Mitt Romney money were talking about here. Yes, Mitt has an IRA.
Now…. there are some rules. (Dammit! there are ALWAYS rules!!!!). First, you can’t touch this money again until you have some wrinkles. Like, maybe a lot of wrinkles. Like 59.5-ish years of wrinkles. But, you do get to keep this money in your name and not give it to our ohh-so-effective government. Second, it does indeed get taxed when you finally dive into the pot of gold, buuuut, when you DO touch it, the money you contributed and income from the investments, can be taxed at a much lower rate than if you were to just dump it into your checking account today. That tax rate depends on when you retire, what your income is at that time, and what the stock market has done over the years. The income you make from your investments in an IRA is also tax deferred, meaning you are not getting hit with taxes as the money grows. This is a HUGE benefit of putting your money in an IRA. Basically it allows you to make lots of money over time, and pay less % in tax. Hanging with me? Uhhh, let’s see.. How about we look at some numbers.
Say you did $150,000 in revenue last year (this is the amount of money you collected prior to expenses, write-offs, and taxes). Let’s also say you spent $50,000 of that on running your business. This would leave you with a profit of $100,000. Good on ya! You’re ballin!
Now a good rule of thumb is that you would pay ~33% in taxes (that number is merely a fantasy here in CA). So, go on, get out your pen and write that $33,000 check! POOF! GONE! But wait… where does our SEP IRA come into play?
After you’ve run your numbers for last year, you can calculate your maximum allowable contribution to a SEP IRA and promise to make that investment before you file your taxes. Heard of filing an extension? Yah, that comes into play.
So, what’s the maximum SEP contribution for your $100,000 profit business? The calculation comes out to roughly 22% of your *profit*. There is of course a very specific calculation behind this. The Federal stated maximum in 2013 is 25% of your profit or $50,000, which ever is less, but there are a few factors that make that number a little closer to 22% if you are looking for a quick number. For our guestimation purposes we will use ~22%. Again, I’m not liable for these numbers! Twenty two percent of $100,000 is…. Uhhh… engineering degree come back to me… uhhh… Oh! $22,000!!!!
At this point you and your accountant agree that you will file an extension on your taxes (you promise that all your numbers will add up by October instead of April 15th). You also make the commitment to put that $22,000 into a SEP IRA. Then, in October you get to write off that $22 G’s and only get taxed on the $78,000 thats left. Now you owe ~33% of $78,000. What’s that number? Roughly $25,000. Look at that, you just saved yourself $8,000 ($33,000 down to $25,000) and that’s assuming your deduction didn’t even put you in a lower tax bracket.
Now, you do have to come up with the money. Come October (not April!) you would have invested $22,000 into your SEP and paid your $25,000 in taxes. Thats $47,000 out of pocket. YIKES! No small task, BUT a good chunk of that money is still yours and invested in stocks that will be making you paper baby! Get ’em Apple stock!
I actually did this exact strategy described above for my 2011 taxes… in the end I was able to prevent myself from sending an additional $7,200 to the government. HOLLERRR!!!! More confetti people! I’m doing a freaking Irish Jig up in here! Michael Flately was just like, “Woah, that guy is good!” In addition, that $7,200 is now in a managed investment account which will grow exponentially the longer I leave it in there. Double win!
I should also mention that a professional tax accountant cost money. I paid ~$500 for mine to run my numbers and he saved me $7,200. Seems like a good use of money to me.
I’d love to refer you to my accountant Alan Pinck who runs an office down in Santa Clara as well as San Ramon. He can be found at http://apincktax.com
Also, you’re going to need a financial advisor to set up that SEP IRA for you. Luckily I’ve connected with one here in the Bay that is willing to help. His company is not comfortable with me putting his info on here, so send an email to firstname.lastname@example.org and Ill give you a personal referral.
If one person reads this and makes it happen this year I am going to hug the closest person to me like 17 times.
Thats about it folks!