The $8,000 First Time Home Buyer Tax Credit that was set to expire on November 30 was extended today. The new deadline to take advantage of the first time home buyer credit is to have a signed contract by April 30, 2010 and close on the house by June 30, 2010.

Update: The first time home buyer tax credit is extended until Sept. 30, 2010.

First Time Home Buyer Tax Credit

As a reminder, here are some of the rules for the first time home buyer tax credit:

• The credit is for $8,000 or 10% of the home’s value, whichever is less.
• The credit is refundable.
• The credit is for primary homes that cost $800,000 or less.

The income limits also went up with the extension. Original phaseouts were for incomes between $75,000 to $95,000 for single and $150,000 to $170,000 for couples. Phaseouts will now begin at $125,000 for single and $225,000 for couples.

In addition to extending the date, the bill also included a $6,500 Home Buyer Tax Credit for Existing Homeowners.

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Solo 401k or a SEP-IRA, which one is the best retirement plan for the self-employed?

When I told you about my struggles with my Solo 401k contribution at Fidelity, Lee suggested I look at the SEP-IRA, which made us take a step back and relook at all the available plans; the Solo 401k, the SEP-IRA, and the SIMPLE IRA.

All three plans are available to sole proprietors, partnerships, and C or S corporations.

I promised to share my perspective after we highlighted each plan. Here’s my take:

When You Want a SEP-IRA

There are a few instances that a SEP-IRA is your obvious choice:

Do you have employees? If the answer is yes, you’re going to want to open a SEP-IRA. You cannot open a Solo 401k if you have employees; it’s only for the business owner and spouse.

Is the calendar year over? If the answer is yes, and you still want to make a contribution for the prior tax year, the SEP-IRA is the way to go. You can open and fund a SEP-IRA until the tax filing deadline, plus extensions. In contrast, a Solo 401k has to be established by December 31, but can be funded until the tax filing deadline, plus extensions. If you are planning for next year, act now, and you can establish either plan.

When You Want a Solo 401k

Are you planning Roth conversions? A benefit of the solo 401k is that you won’t have to include the contributions in the pro rata calculation. However, a SEP-IRA will be included in the Roth IRA Conversion calculation.

If you have any plans to make Roth conversions on non-deductible IRA contributions, steer clear of the SEP-IRA, or you’ll be increasing your tax bill on the conversions.

Do you want to maximize your deferral? The Solo 401k is the big winner. Here are the contribution limits:

• 2009 Solo 401k Limits: $16,500 employee deferrals ($22,00 age 50 or older) plus 25% of compensation; maximum of $49,000($54,500 age 50 or older).
• 2009 SEP-IRA Limits: 25% of compensation; maximum of $49,000.

While the limits appear similar, each having a $49,000 maximum, they actually aren’t. Let’s take a closer look at the calculations.

Calculating Maximum Contributions

To calculate the 25% profit sharing contribution, you need to account for the deduction of the plan contribution in the formula in addition to half the self employment tax. So a 25% contribution rate, looks like this:

(Net income – 1/2 self employment tax – profit sharing) * .25 = profit sharing.

It’s actually the same as a 20% self employed rate, which some people prefer to use:

(Net income – 1/2 self employment tax) *.20 = profit sharing.

Here’s an example:

Let’s say your net income is $20,000. Half of your self employment tax is $1412.96. So your profit sharing contribution is $3717.41.
($20,000 – $1412.96 – $3717.41) * .25 = $3717.41
or ($20,000 – $1412.96) * .20 = $3717.41

For the solo 401k, you can defer 100% of your compensation. To calculate your compensation use the prior formula: (Net income – 1/2 self employment tax – profit sharing). ($20,000 – $1412.96 – $3717.41) = $14869.64. Add the profit sharing contribution to the employee deferral ($14869.64 + $3717.41) = $18587.05.

Total solo 401k contribution: $18587.05
Total SEP-IRA contribution: $3717.41

As you can see, this is where the solo 401k is the big winner. If you want to skip the hand calculations, you can use a calculator to determine your maximum contribution.

Simple IRA?

What about the SIMPLE IRA? I didn’t include it, since the contribution limits don’t even come close to the Solo 401k or the SEP-IRA. If you have employees, and want to let them make contributions, it might be a good choice, however, at that time, you’ll want to compare the SIMPLE IRA to a 401k.

Action Plan

I decided to stick with the Solo 401k since the plan contributions are so much higher and our goals are to defer the maximum amount of money. In addition, we’re planning Roth conversions in 2010, so I want to minimize our taxes for the conversions.

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The tax extension deadline, October 15, is just around the corner. If you filed an extension back in April, your individual tax return is due on Thursday. Helpful tax information to finish your return can be found in The Ultimate Tax Resource Guide.

Extension Tax Returns

To file your tax return, you can use any of the following software for do-it-yourself filing:

• TaxCut
• TurboTax
• 6 Free E-File Options

Retirement Plan Contributions

Is your tax bill higher than you anticipated? You can still make contributions to your self employed retirement accounts to reduce your tax bill. See the following retirement plan details:

• SIMPLE IRA
• SEP-IRA
• Solo 401k

Tax Planning for Next Year

Once your return is filed, it’s time to plan for next year. Check out 17 Tips for End of Year Tax Planning for ideas.

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Today we’ll wrap up our look at various retirement plans ideal for small business owners and the self-employed with the one that inspired the series – the Solo 401k. So far, we’ve looked at the SEP-IRA and the SIMPLE IRA.

Solo 401k Overview

A Solo 401k combines the characteristics of a regular 401k plan with a profit-sharing plan. A Solo 401k can only be established by self employed individuals or small business owners with no other employees or just one employee – the owner’s spouse. For most people with no employees the Solo 401k will maximize the allowable contributions you can make to a retirement plan in a given year.

Solo 401k Basics

• Coverage: A Solo 401k is only established for the business owner and the business owner’s spouse if he is an employee.
• Contributors: Solo 401ks are funded by both the employee and the business. The employee contribution is deferred compensation while the business contribution is a portion of profits.
• Contribution limits: In 2009, an employee can defer up to $16,500 to a Solo 401k. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $5,500. The total amount allowed is reduced by any contributions to a 401k, 403(b), or 457 at another employer. In addition to the employee deferral limit, the business can make a contribution of up to 20% of your total income (25% of earned income, which is total income reduced by self-employment taxes). The total employee and employer contributions must not exceed $49,000 in 2009, or 100% of your income.
• Deadlines: You must establish the plan by December 31 of the calendar year for which you first want to contribute. Contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. For most people this is October 15 of the following calendar year.
• Taxation: Both individual and business contributions to a Solo 401k are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
• Vesting: There is no vesting period for Solo 401k contributions. Note that this is different from most tradtional 401k plans.
• Withdrawals: Solo 401k withdrawals are subject to the same withdrawal rules as regular 401ks. All withdrawals will be subject to income tax. Penalties may apply if taking withdrawals before the age of 59 1/2. A unique feature of Solo 401ks as opposed to other self-employed retirement options is that loans may be available depending on how the plan is set up.

Special Characteristics

• Once the plan reaches $250,000 in assets, you must complete a Form 5500.
• A Solo 401k can accept rollovers from many other retirement plans, making it easy for you to consolidate accounts in one place before beginning withdrawals in retirment.
• Contributions are discretionary, so you can choose not to contribute in years where your business has low revenue and increase contribution if you want to minimize taxes.

Establishing a Solo 401k

There are no regulations governing the establishment of a Solo 401k. You can open one with most major financial institutions, including Vanguard and Fidelity.

Solo 401k Pros

The biggest advantage of a Solo 401k is that it typically allows for the largest contribution when compared to other self-employed plans.

Solo 401k Cons

You cannot use a Solo 401k if you have any employees other than a spouse.

Stay tuned Madison’s wrap-up of this series: an analysis of which self-employed retirement plan is best, in Solo 401k Versus SEP-IRA.

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SIMPLE IRAs are up next as we continue the series exploring three different types of retirement plans ideal for small business owners and the self-employed. Yesterday, we started the series with an in-depth look at the SEP-IRA.

SIMPLE IRA Overview

SIMPLE stands for Savings Incentive Match Plan for Employees. SIMPLEs were established to encourage small businesses to open retirement plans without the expense of maintaining a qualified plan.

Only businesses with less than 100 employees are eligible to establish a SIMPLE. A SIMPLE can actually use an IRA or a 401(k) to “hold” the contributions, but we are focusing only on the SIMPLE IRA since the 401(k) is rarely used. SIMPLE IRAs are easy to establish, have no annual filing requirements, and relatively few administrative expenses.

SIMPLE IRA Basics

• Coverage: SIMPLE IRAs must cover all employees who either made $5,000 in two preceding calendar years or are expected to make $5,000 in the current calendar year.
• Contributors: SIMPLE IRAs are funded by both employees and employers. Employees contribute by deferring a certain percentage of their income. Employers can choose to either match employee contributions or contribute to all eligible employees, regardless of participation. Employers who match contributions must generally match 100% of contributions up to 3% of employee compensation, with some exceptions. Alternatively, employers can contribute 2% of compensation to all eligible employees.
• Contribution limits: During 2009-2012, the maximum SIMPLE IRA contribution per employee is $11,500 per year, including the employer match. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $2,500. The catch-up amount is reduced by catch-up contributions to a 401(k), SEP-IRA, or 403(b).
• Deadlines: Employers must establish SIMPLE IRA plans by October 1 of the calendar year that employees can first contribute. Employer contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. Note that this only applies to the employer match portion. The employer must forward compensation deferred by employees no later than 30 days after the end of the month in which it was deferred (e.g., April 30 for March contributions).
• Taxation: Both employer and employee contributions to a SIMPLE IRA are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
• Vesting: There is no vesting period for SIMPLE IRA contributions. An employee has access to 100% of the contributions as soon as they are made.
• Withdrawals: SIMPLE IRA withdrawal rules are the same as those for traditional IRAs. Employees can withdraw at all times, including while they are employed. Withdrawals will be subject to ordinary income tax regardless of age or reason for withdrawal. In addition, SIMPLE IRA withdrawals will be subject to a 10% penalty if the account owner is younger than 59½. Some exceptions to the 10% penalty apply. If it is applicable, the 10% penalty increases to 25% if withdrawals are made within the first two years of participating in the SIMPLE IRA.

Special Characteristics

• Employers who maintain SIMPLE IRAs cannot maintain any other type of retirement/deferred compensation plan.
• SIMPLE IRAs can be rolled over to other SIMPLE IRA accounts for the first two years of plan participation without tax or penalty. After two years, you can do a tax- and penalty-free rollover into an IRA, qualified plan, 403(b), or 457.
• Airline pilots, nonresident aliens, and union employees who have separate retirement agreements can be excluded from the coverage requirements noted in the “Coverage” section above.

Establishing a SIMPLE IRA

To establish a SIMPLE IRA, an employer must only file a Form 5304 SIMPLE or a Form 5305 SIMPLE. The first is for employers who allow participants to select an institution to hold their SIMPLE IRAs, while the second allows the employer to select the institution for all employees. Any financial institution that offers traditional IRAs should be able to set up SIMPLE IRAs.

SIMPLE IRA Pros

The biggest advantage of a SIMPLE is that it allows both employers and employees to save in a manner similar to a qualified plan without extensive set-up or administrative fees.

SIMPLE IRA Cons

Because a SIMPLE IRA requires contributions to all employees, it is not a good plan for someone with employees who only wants to beef up his or her own retirement savings. The SIMPLE IRA has a lower contribution limit than any other retirement plan. If your small business is the sole source of your income and you make more than a few thousand dollars, a SIMPLE IRA will severely limit your ability for tax advantaged retirement savings.

Stay tuned for more in the series, including an explanation of Solo 401ks, and Madison’s analysis of which is best, in Solo 401k Versus SEP-IRA.

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