Congratulations on your being an entrepreneur! One of the often overlooked aspects of going out on your own is being able to build your strategy from the ground up. Most new ventures have to start with an income of $0 the first day and it becomes a building process of both spreading the word about you, your service, or product and most importantly delivering value. Starting from scratch isn’t all that bad though, as there is a strong motivation to increase that number from $0 and there are a few valuable strategies that you may be able to activate during the early years. Also, if you are shooting the lights out right away you may benefit from deferring income.
Lower Income & Business Expenses = Lower Taxes
If you project that your income for the current tax year is likely to experience a dip, hopefully, you have a game plan in place to plan for that income gap. The lower income, along with business expenses means that it is very likely that your tax situation will be significantly lower than previous years. During this time there are a few things you’ll want to take inventory of:
- Taxable Investments (non-retirement)– These assets may have experienced a significant amount of growth over the last 8 years and could have pent-up capital gains, which is a tax liability. That is unless you fall below the income tax threshold for capital gains tax (2018 limits: single filers- $38,600, married filing joint- $77,200). If you are in the range where no capital gains taxes are due, this is a unique time period to sell the asset and recognize the gains, you can buy the assets right back as there is no rule for “wash sale” like there is for selling and recognizing losses.
- Tax-Deferred Retirement Accounts (401(a), 403(b), 401(k), IRA, SEP)- All distributions from these accounts will require that they are included as ordinary income on your taxes. That is not necessarily a bad thing if your income tax rate is lower than it has been in previous years. In order to avoid a 10% penalty for early withdrawal for those under the designated retirement age of 59 ½, you will want to use the Roth conversion strategy.
- A Roth conversion allows you to keep your tax-deferred retirement funds in a retirement account, but strategically maneuvers them so that you recognize the income and taxes now and never have to pay income taxes for the funds in the Roth account ever again.
- Taxable Income, Tax Bracket, & Capital Gains– If you choose to strategically make moves in either of the first two scenarios, you want to make sure that you are planning correctly. To do this you want to have a really strong idea of where you will be at the end of the year, or just wait until the end of the year when you will have a greater chance of making accurate projections. The thing everyone hates most during tax season is another surprise, as always, I advise consulting a professional to verify your plan.
One of the largest benefits most employees give up when they leave to start their own venture is access to affordable health insurance. The cost of health insurance without employment assistance is staggering, to state it mildly. However, if you plan to have low income in the early years of your business, there is a possibility of taking advantage of health insurance subsidies that greatly reduce the burden of accessing health insurance.
To qualify, your income must fall below certain income limits based on your household size. You can plug in hypothetical projections at https://www.kff.org/interactive/subsidy-calculator/
If a spouse has access to family health insurance, that option may be preferred even if you are able to get the largest health insurance subsidy.
There are risks associated with relying on the current healthcare market. It is very possible the markets may not continue either because of government action or through insurance companies backing out of the marketplace. If the market remains, government provided health insurance subsidies may be reduced or may change their calculation to take into account assets rather than income.
Using your respective state’s site for the insurance market will be a good resource and may even be able to connect you with an insurance agent that can guide you through the various tradeoffs of your plans.
More Money = More (Tax) Problems
All employees of another company have access to either an employer retirement plan like a 401(k) or can open their own IRA to defer income and save for retirement. When it comes to being a business owner, there are a few more options to choose from, but if you have no employees other than a spouse I prefer a Solo(k) or Single(k). A Solo (k) and Single (k) are similar, but there are subtle differences that you’ll want to review to make sure you choose the best one for your situation
The biggest positive of both of these accounts is the ability to have a significant amount of income saved towards retirement accounts. As much as $54,000 ($60,000 if over 50 for catch up) can be added depending on your company’s income (see details below). This is helpful either for tax deferral, which reduces your tax burden or after-tax contributions (Roth).
Although the administrative responsibilities are not overly burdensome, they definitely are more complex than a SEP IRA account or a Simple IRA account. If you are not necessarily looking to max out your annual contributions, then those accounts may be worth researching in greater detail.
Starting a new venture is an amazing and chaotic experience, but there is so much planning that can be done from both a business and a personal finance standpoint. This is most likely a unique time for your income that may allow you to implement strategies that can save you a tremendous amount in taxes, as well as, build confidence that you are making the most of this time.