Keogh or Sep IRA for Traders

Quote from jwishcamper:

Hi I Missed the Boat:

No, I think you may have misunderstood my posting. I did not mean the LLC route will not work to generate earned income. To the contrary, I think it will.

My posting to Aaron was addressed solely at the hypothetical he presented, which was a situation where a husband manages his wife's brokerage account and takes a fee from it. There was no entity in that situation. I commented in my posting that I was not addressing the situation with entities, and I said, "If it is an entity arrangement, then disregard what I am about to write."
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ok, thank you very much. sorry for the confusion! So the only question is, if one starts an LLC, how many people does he or she need to have in it, and does the person have latitude as to how much of what they make is "earned?" Otherwise, all money would be hit with social security.

Also, does anyone know how this new IRA tax credit works? Thank you!
 
You need to have at least two members in the LLC, otherwise it is treated as a "disregarded entity" by the IRS--in which event it is a sole proprietorship, and you haven't accomplished anything by setting up the LLC (at least not tax-wise).

The LLC can pay a "reasonable" management fee to the manager. What constitutes a "reasonable" management fee depends on the facts and circumstances, so there's no hard and fast answer there. I think the best analogy is to the fees paid to general partners to manage a limited partnership. I saw one such fee last week that was in the neighborhood of 25% of profits, but I haven't researched that issue in a while so I'm not sure of the range of fees being charged these days.
 
Quote from jwishcamper:

You need to have at least two members in the LLC, otherwise it is treated as a "disregarded entity" by the IRS--in which event it is a sole proprietorship, and you haven't accomplished anything by setting up the LLC (at least not tax-wise).

The LLC can pay a "reasonable" management fee to the manager. What constitutes a "reasonable" management fee depends on the facts and circumstances, so there's no hard and fast answer there. I think the best analogy is to the fees paid to general partners to manage a limited partnership. I saw one such fee last week that was in the neighborhood of 25% of profits, but I haven't researched that issue in a while so I'm not sure of the range of fees being charged these days.
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Thank you so much! You are obviously a very good accountant, especially for traders.

Does anyone know, however, if already trading within an LLC negates any possibilities for gaining "earned income" outside of a second job. I take it that someone working for an LLC can't create an LLC. Are there any other ways to gain "earned income?"
Thank you!
 
Quote from jwishcamper:

You need to have at least two members in the LLC, otherwise it is treated as a "disregarded entity" by the IRS--in which event it is a sole proprietorship, and you haven't accomplished anything by setting up the LLC (at least not tax-wise).

The LLC can pay a "reasonable" management fee to the manager. What constitutes a "reasonable" management fee depends on the facts and circumstances, so there's no hard and fast answer there. I think the best analogy is to the fees paid to general partners to manage a limited partnership. I saw one such fee last week that was in the neighborhood of 25% of profits, but I haven't researched that issue in a while so I'm not sure of the range of fees being charged these days.
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i have a question regarding the llc. if i set up a llc, and make 200K trading that year, am i able to not pay myself that full amount? Could i pay my wife 40K for administrative and myself 160K? could we then both contribute up to 25% of that to a sep ira? and also deduct health premiums? thanks...it always helps me to use numbers in these illustrations...
 
Hi Boomer:

Let’s take the easiest part first: Yes, you can pay medical insurance premiums for yourself, spouse and dependents as a deductible expense through the LLC, but this deduction is limited to “earned income” you have been paid. That leads to some of your earlier questions.

It is possible to pay yourself and your spouse what is known as “guaranteed payments” through the LLC in exchange for services rendered. So yes, you could pay reasonable compensation to your spouse for her administrative services just the same as you could go hire some third person to do the same tasks. Such guaranteed payment would be deemed self-employment income and she would have to pay the 15.3% self-employment tax on it. This payment would constitute earned income to your spouse.

You could also pay yourself reasonable compensation for providing management to the LLC. Such payment would also be a guaranteed payment, it would be subject to the 15.3% SE tax, and would constitute earned income to you—thereby satisfying the “earned income” requirement to support the deduction for the medical insurance premium referenced above. I’m not sure whether $140k would constitute reasonable compensation, or whether the IRS might deem that to be excessive compensation. One would need to do research on that. However, I’m hard pressed to see why the IRS would complain—after all, the entire amount is being taxed under both the SE tax and the income tax. The IRS usually complains that too little tax is being paid, not that too much tax has been paid.

Finally, yes, these earned income payments would indeed support contributions into a SEP-IRA. The 25% limit to which you refer is for the employer contributions. The employee’s limit is $3k, or $3,500 with a catch-up contribution if you are age 50 or over.
 
A couple more question from your response.

1- regarding the se tax, is that paid on top of the 34% fed tax?

2- if i make 200K trading in a year, and pay my spouse her 35K, and pay myself 100K,is the remaining amount taxed? the left
over 45K that stays in my trading account, what happens to it?

3- i know yall reccomend setting up an llc. what are the management fees most people pay to themselves? im trying to just get a ballpark figure? and what is done with the years trading profits that are not paid to the trader and other workers?

thanks for your help...




Quote from jwishcamper:

Hi Boomer:

Let’s take the easiest part first: Yes, you can pay medical insurance premiums for yourself, spouse and dependents as a deductible expense through the LLC, but this deduction is limited to “earned income” you have been paid. That leads to some of your earlier questions.

It is possible to pay yourself and your spouse what is known as “guaranteed payments” through the LLC in exchange for services rendered. So yes, you could pay reasonable compensation to your spouse for her administrative services just the same as you could go hire some third person to do the same tasks. Such guaranteed payment would be deemed self-employment income and she would have to pay the 15.3% self-employment tax on it. This payment would constitute earned income to your spouse.

You could also pay yourself reasonable compensation for providing management to the LLC. Such payment would also be a guaranteed payment, it would be subject to the 15.3% SE tax, and would constitute earned income to you—thereby satisfying the “earned income” requirement to support the deduction for the medical insurance premium referenced above. I’m not sure whether $140k would constitute reasonable compensation, or whether the IRS might deem that to be excessive compensation. One would need to do research on that. However, I’m hard pressed to see why the IRS would complain—after all, the entire amount is being taxed under both the SE tax and the income tax. The IRS usually complains that too little tax is being paid, not that too much tax has been paid.

Finally, yes, these earned income payments would indeed support contributions into a SEP-IRA. The 25% limit to which you refer is for the employer contributions. The employee’s limit is $3k, or $3,500 with a catch-up contribution if you are age 50 or over.
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Quote from jwishcamper:

You need to have at least two members in the LLC, otherwise it is treated as a "disregarded entity" by the IRS--in which event it is a sole proprietorship, and you haven't accomplished anything by setting up the LLC (at least not tax-wise).
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Green Trader Tax sets up single member LLCs with which you can fund social security and get to create a self employed 401K. They seem pretty confident in the correctness of the setup. (I thought the bias against single person LLCs was eliminated in the law.)

http://www.greencompany.com/Traders/TraderEntities.shtml#smllc

A single-member LLC tax return is basically the same as a sole proprietor (unincorporated) trader's tax return.

In both cases, all trading expenses are reported on Schedule C (Profit or Loss from Business), MTM trading gains and losses are reported on Form 4797 (Sale of Business Property – Part II Ordinary Gain or Loss), and interest and dividend income are reported on Schedule B (Interest and Dividends).
The differences with the single-member LLC are that the LLC tax identification number (EIN) – as opposed to the sole proprietor’s social security number – is reported on the Schedule C, and the LLC is entitled to pay the owner a salary to create earned income.

The key tax difference (and source of tax benefits) is that a single-member LLC may have a second Schedule C, filed by the "manager" of the LLC trading business. The second Schedule C reports a fee from the LLC trading business, which is the filer of the first Schedule C. This is a "wash," and there is no difference in overall income – the first Schedule C deducts an amount equal to what the second Schedule C reports as income.

The key reason to do this is to create "earned income." That second Schedule C (filed by the “manager”) has "earned income," which is subject to self-employment taxes. The first Schedule C (filed by the trader) does not. A trader needs "earned income" to deduct retirement-plan contributions and health-insurance premiums.


Single person 401k plans for self-employed
http://www.greencompany.com/Traders/TraderRetirement.shtml
 
Hi Boomer:

This needs to be my last post on this thread. I’m bogged down with the workload from the upcoming tax season, so I am not able to continue with the follow-ups on this thread. But here’s my closing shot on this:

1. Yes, the 15.3% SE tax is on top of the federal income tax, for which the top rate is presently 35%. That’s the price Congress demands we pay to have “earned income” to make contributions into a retirement plan in order to get the tax deferral.

2. The remaining amount of profit within the LLC (i.e., the amount remaining after paying out the guaranteed payments) is allocated to the owners according to their percentage of ownership, and is taxable to those owners. This is true whether the profit is actually distributed out to those owners or whether it is retained within the LLC so the brokerage account can grow and compound. That is the flow-thru tax nature of the LLC.

3. See answer to Question 2 re undistributed profits. As to what constitutes a reasonable management fee, it depends. I’ve seen fees range from 2% on the low to 50% on the high, but it may be that under a particular set of facts and circumstances, a higher fee could be justified. I invite the other Forum participants to discuss what sort of management fees they have seen in such LLCs.
 
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