You’re probably aware of how great mega back door Roth’s are. But do you know how to calculate mega back door Roth contributions for a sole proprietor?
This article will walk through the calculation and give you some insights to simplify the process.
A couple handy forms for your reference:
Schedule SE. This schedule will calculate the self-employment tax for the Schedule C business profits. You can find it here: https://www.irs.gov/pub/irs-pdf/f1040sse.pdf
IRS calculations from the IRS site: https://www.irs.gov/retirement-plans/one-participant-401k-plans
IRS Retirement Calculator Guide: Self-Employed Individuals – Calculating Your Own Retirement-Plan Contribution and Deduction | Internal Revenue Service (irs.gov)
IRS Publication 560: Publication 560 (2021), Retirement Plans for Small Business | Internal Revenue Service (irs.gov)
Mega Components
First of all, Mega Backdoor Roths are combined generally with three types of contributions:
- Employee deferral
- Profit sharing
- After-tax contributions
The combined amount of the above items cannot exceed the annual 401(k) limit. The limits for 2022 and 2023 are as follows:
| 2022 | 2023 | |
|---|---|---|
| Under age 50 | $61,000 | $66,000 |
| 50 and over | $67,500 | $73,500 |
Mega Backdoor Roth Calculation Example
Let’s look at an example with the following assumptions:
| Assumption | Variable |
|---|---|
| Plan year | 2022 |
| Client Age | 40 |
| Sole proprietor net income | $90,000 |
Determine Employee Deferral
| 2022 | 2023 | |
|---|---|---|
| Under age 50 | $20,500 | $22,500 |
| 50 and over | $27,000 | $30,000 |
Calculate self-employment tax
Once you know the basic plan assumptions, the first step is to calculate self-employment tax. This is actually done using Schedule SE noted above. Most CPAs have software that calculates this, so it is not really a manual process.
But the self-employment tax calculation is not that challenging. Most people know that it is approximately 15%, but there are a couple adjustments.
First, take the net income of $90,000 and multiply it by 92.35%. This calculation reduces for one-half of self-employment tax (7.65%). The result of this calculation is $83,115. Then you multiply this amount by 15.3%. The resulting self-employment tax is $12,716.
Calculate Profit Sharing Contribution
There is a specific computation to determine the maximum amount of elective deferrals and profit-sharing contributions you can make. When determining the contribution level, your compensation is actually “earned income,” which the IRS defines as net self-employment earnings once you deduct both:
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- one-half of self-employment tax, and
- contributions for yourself.
| Sole proprietor net income | $90,000 |
| Less: 1/2 SE tax | ($6,358) |
| Net profit reduced by ½ SE tax | $83,642 |
