How Small Businesses Can Lower Taxes with a 401(k)

By Stuart Robertson

Few Americans feel a tax burden more than small business owners. There are business income taxes, employment taxes, personal income taxes, and more that each small business owner must shoulder each year.

If you’re a small business owner and feel you’re paying too much to Uncle Sam, you’re not alone. The good news is that there are a few smart ways to gain additional tax savings. One great way is by starting a company retirement plan. With high contribution limits, tax credits, and tax-deductible expenses, a 401(k) plan can provide rich benefits for both the owner and their employees. In fact, with these tax benefits and the introduction of low-cost providers, 401(k) plans are becoming much more popular for every size business, including the self-employed.

Five Tax Benefits of a 401(k)
There are at least five tax-specific benefits that make setting up a 401(k) plan a smart move for any business:

  1. Shelter up to $61,000 from 2022 Taxes: Go ahead and up that number to $67,500 if you’re at least 50 years old. As an employee of your company, you may contribute up to $20,500 to the plan from your salary ($27,000 if age 50 or more), and you can also receive any matching and/or profit-sharing contributions that you provide to the plan up to the limits. This tax savings alone may cover all of the plan costs for some small firms.
  2. Receive up to $15,000 in tax credits: Businesses with at least one employee (in addition to the owner) and up to 100, qualify for an annual tax credit of up to $5,000 to offset half of the administrative costs of the plan for the first three years – that’s a potential cumulative savings of $15,000 over three years. You’ll likely experience less than this amount in credits as providers that are competitively priced for small businesses. Administrative costs will vary by the number of employees that participate in your plan. For a business with 10 employees just starting their first retirement plan, expect to pay about $1,200 a year. Subtract the credit that covers half, and that’s a pretty low-cost plan at $600 per year.
  3. Hedge future taxes with a Roth 401(k): A Roth 401(k) enables small business owners and employees to make after-tax contributions with no income level restrictions – unlike the popular Roth IRA that has income limits. This means that employees that use the Roth 401(k) option will have the advantage of tax-free withdrawals – earnings and all – when they use these funds in retirement. Owners and employees can choose to put all, part, or none of their personal contributions into their Roth. The caveat here is that any company match you do must be made on a tax-deferred basis and not into your Roth.
  4. If you choose to match, it’s tax deductible: Employer contributions are optional in 401(k) plans. But without a match or other employer contribution, it can limit how much highly compensated employees (including owners) can put into their 401(k) account. The good thing is that by providing a relatively small match to eligible employees, you can maximize your contributions. Employer contributions are often a 100% tax-deductible expense for your business, too.
  5. 401(k) profit sharing can help manage business taxes: Profit sharing is discretionary for your business. You can provide one in good years and cut it out in tougher times. The amount of profits you share will lower your business earnings, so there is less for the IRS to take. The amount you put into the 401(k) is also tax deductible for your company. And there’s more good news. The profit share will increase your 401(k) account savings, and since it’s a tax-deferred contribution, there are no personal tax consequences. You and your tax advisor can run the numbers each year and determine what amount is best for your organization.

Start Now to Avoid Next Year’s Tax Hit
To ensure maximum tax benefits in the year ahead, it pays to get started sooner than later. Talk to your tax advisor and see how a small investment in a 401(k) can pay big dividends now as well as later when you decide it’s time to retire.

This material is intended only as general information for your convenience and should not in any way be construed as investment or tax advice by ShareBuilder 401k. The owner/participant should consult with their tax advisor regarding any specific tax strategies.

Meet the Author

Our low-cost 401k plans are easy to setup online and are supported by our 401k advisors and specialists. ShareBuilder 401k serves small business and medium-sized companies, as well as the self-employed. We offer Roth 401k, Safe Harbor 401k, Traditional 401k, and Solo 401k options. Your 401k plan is paired with investment management expertise and employee education to help you save more.