Trade Strategies for Retirement and Trader Taxation

Tax Planning Time Machine

Without fail, it happens every year. I’m not talking about the latest Hollywood hook up or D.C. scandal. What I’m referring to is something I like to call the “Hero Syndrome.” Every year I get contacted by frantic traders who are looking for a hero to swoop in and save them from the evils of high taxes. It would be great if I could just jump in my tax-planning time machine and go back to last year, but the real world doesn’t work this way. The reality is if you are not proactive in reducing your taxes, you severely limit yourself to what you can do come April 15th. Once January 1st rolls around, it’s going to be too late to implement the best strategies that could save you thousands of dollars in taxes.

So with the book just about closed on the 2014 tax filing season, let’s take a look at some tax savings strategies that you may have missed last year. I am going to assume you are a profitable trader in the 25% tax bracket to keep my calculations consistent.

Hire Your Kids

If your kids are any thing like mine, they cost money! Dance competition fees and competitive soccer (just to name two) can really add up during the year. How would you like to be able to deduct these types of expenses as a business expenses? If your kid is over the age of 7, the IRS says they are old enough to work. Hiring your kids to work in your business has many benefits and makes financial sense from a tax stand point. You need to keep track of their hours worked and pay them a reasonable wage ($200 an hour to empty your trash is a no-no), but otherwise there are no restrictions to what type of work they can do for you. Your kids can then use their own money on the expenses you normally pay for and your business gets the deduction! If you pay them under $6,200, there will be no federal income taxes owed on their income.

  • Potential Tax Savings: $6,200 x 25% = $1,550 per kid

Individual 401(k) Plan

The Individual 401(k) plan, or Solo 401(k), is one of my favorite tax planning tools for profitable traders to save big time on their taxes. The Solo 401(k) allows you to contribute up to a maximum of $18,000 or 100% of your income each year. The key is the 100% of your income component. A trader can pay themselves (setting up payroll) a salary of around $19,000 (to cover Medicare and social security taxes) and contribute $18,000 of that into a retirement plan and save federal income taxes on that contribution. On top of that, as the employer, you can contribute up to 25% of compensation to the Solo 401(k) to increase the tax savings. The employer contribution is not subject to Medicare or social security taxes, so it is pure tax savings. If you are married and your spouse doesn’t participate in a retirement plan at work or doesn’t work outside the home, you can pay him/her to work in your business and double your tax savings! Please keep in mind that the Solo 401(k) plan is for owner only businesses and their spouses. You wouldn’t be able to hire your kids on your payroll if you implement this plan. However, the tax savings is much greater.

  • Potential Tax Savings: [$18,000 + $4,750 (employer contribution)] x 25% = $5,688
  • Adding your spouse gives you a tax savings of $11,376!

Health Care Premium Deduction 

If you are a full-time trader and pay for your own health care, there are only two ways you can deduct this expense. The first way, and most common, is to take the deduction on Schedule A, as an itemized deduction. The problem with this strategy is the IRS puts a 10% floor in for itemized medical deductions. This floor means that the first 10% of your adjusted gross income (AGI) is not deductible. For example, let’s assume that you pay $10,000 a year for your health insurance. If your adjusted gross income is $100,000, your floor is $10,000…meaning you get to deduct $0 of your health premiums on your schedule A!

If you are a profitable trader, you can set up payroll for yourself. Your health care premiums get added to your wages at year end (but not subject to Medicare or social security taxes). The business gets the deduction and you can take the self employed health insurance deduction on Line 29 of your Federal 1040, thus making it non-taxable to you.

  • Potential Tax Savings: $10,000 (health insurance premium amount) x 25% = $2,500

Will Rogers once said, “We all have to pay taxes but you don’t have to leave a tip!” Being proactive and using the existing Internal Revenue Service rules to your advantage is what you pay your tax advisor to do for you.  These are just a few of the strategies that I recommend to my clients who are profitable traders to save them thousands of dollars in taxes each year. I would encourage you to have a conversation with your tax advisor to see if any of these or other strategies might be right for you.


For more info about Steve Ribble, please click here.


Related Reading

5 Tax Reminders For Traders

How to Audit Proof Your Trader Tax Statu