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Case Study – How one person reduced their tax liability by 43%!

Updated: Apr 23, 2021

There’s still time to save/defer your tax liability for 2020. Here’s a case study as an example of how a self directed solo 401k can help nonemployer business owners and people with 1099 income.

Real numbers case study

This is a case study from an actual client, “Michael”, who is employed by a company that pays him a base W-2 salary (without retirement plan deductions) along with 1099 commissions that are paid to his LLC. Michael is 29 years old, single with no kids, lives in Texas, and adopted his Self-Directed Solo 401(k) plan in December of 2019. When it came time to prepare Michael’s 2019 tax return his CPA ran the numbers to compare his tax liability as if he made no contribution to the Self-Directed Solo 401(k) plan versus making the maximum contribution (see Figure 1).

On the left side you’ll see that Michael’s Business Income from self-employment was $129,404 and he made no Self-Directed Solo 401(k) contributions to the plan, so the Other Adjustments line is blank. Including his base W-2 salary his AGI is $227,492, and his Taxable Income shows as being $215,292. In this scenario, Michael would have a Tax Balance Due of $44,246. His Marginal Tax Rate is 35 percent, and his Effective Tax Rate is 23.34 percent.

On the right side of the table, you’ll see that if Michael contributes $46,714 to his plan, which is the most that he is allowed based on his income, his Taxable Income decreases considerably. His Tax Balance Due plummets from $44,246 to owing the IRS only $25,300. This decreased his tax liability by $18,946, which is a 42.8 percent reduction!

Needless to say, Michael chose to make the maximum contribution to his plan and is enjoying the tax savings. He is also an avid real estate investor, so he can self-direct the $46,714 contribution toward assets that match his preferred investment strategy.

How Michael did it

Michael’s $46,714 contribution consisted of $19,000 (the 2019 limit) as salary deferral + 20 percent of