Financial planning for small businesses SEP IRA vs QBI Deductions

For YouTube topic How to Balance the Choice Between QBI Deduction and SEP IRA Contributions As a small business owner, we all face a tax planning question: • Contributing to a SEP IRA or Solo 401(k) can immediately reduce taxable income for the year, deferring taxes until retirement. • On the other hand, this also reduces net income for the year, which in turn reduces the 20% QBI Deduction (Qualified Business Income Deduction). The income reduced by the QBI deduction is permanently tax-free. So, how do we properly weigh these two options and find the balance? Answer and Recommendations: 1. Benefits of SEP IRA: • Immediately reduces taxable income for the year, saving taxes right away. • Contributions benefit from long-term compound growth, and the tax rate in retirement is generally lower, making it more cost-effective. 2. Advantages of the QBI Deduction: • 20% of the deducted income is permanently tax-free. • The principal amount withdrawn or appreciated through investments in the future is also not taxed, with only the investment gains subject to lower long-term capital gains taxes. How to Balance (Optimal Strategy): • If your current tax rate is high (e.g., 32% or more) and you expect your tax rate in retirement to be significantly lower, it’s advisable to prioritize contributing more to a SEP IRA or Solo 401(k). • If your tax rate in retirement is expected to remain similar or even higher, consider reducing your SEP IRA or Solo 401(k) contributions slightly and taking advantage of more QBI Deduction. • In general, it’s recommended to maintain a balanced approach. For example, aim to contribute 25% to your SEP IRA, but in practice, contribute 10%-15%, while keeping a portion of income to enjoy the QBI tax-free benefit. By doing this, you can maximize both long-term and short-term tax planning benefits. Disclaimer : This video is not a financial advice but please seek professional tax advisor for any guidance