How to Use Retirement Accounts to Reduce Your Business Income Tax

For many small business owners and self-employed professionals, taxes are one of the largest expenses each year. The good news? One of the most effective ways to cut your tax bill is also a smart long-term wealth-building strategy: contributing to a retirement account.

When you contribute to certain retirement accounts, you not only set aside money for your future but also reduce your taxable business income—sometimes by tens of thousands of dollars.

Why Retirement Contributions Lower Taxes

Retirement accounts such as a Solo 401(k), SEP IRA, or Defined Benefit Plan allow you to make pre-tax contributions. This means the amount you contribute is deducted from your taxable income, lowering the amount of profit your business is taxed on.

For example:

You have $150,000 in net business income.

You contribute $40,000 to a Solo 401(k).

Your taxable income drops to $110,000—saving thousands in federal and possibly state taxes.

Top Retirement Account Options for Business Owners

1. Solo 401(k)

Best for: Self-employed individuals or businesses with no employees (other than a spouse).

Contribution limit (2024): Up to $69,000 ($76,500 if age 50+).

How it works: You contribute as both the employee and the employer, allowing much higher limits than a traditional 401(k).

1. SEP IRA

Best for: Business owners with variable income or those who want simple administration.

Contribution limit (2024): Up to 25% of net earnings from self-employment, capped at $69,000.

How it works: Employer-only contributions, flexible each year.

1. Defined Benefit Plan

Best for: High-income owners who want to contribute $100k+ per year.

Contribution limit: Based on actuarial calculations—can be significantly higher than other plans.

How it works: Functions like a pension; you commit to funding a set annual benefit amount.

Combining Plans for Maximum Savings

In some cases, you can combine a Solo 401(k) with a Defined Benefit Plan to supercharge both your retirement savings and your tax deductions. This is especially useful for business owners in their peak earning years who want to reduce taxable income aggressively before retirement.

Steps to Take Before Year-End

Choose the right plan: Solo 401(k) or SEP IRA can be opened quickly, but a Defined Benefit Plan requires setup well before year-end.

Estimate contributions: Work with your CPA to determine how much you can contribute without straining cash flow.

Fund on time: Some plans allow contributions up to your tax filing deadline (with extensions), but the plan must be set up in the current tax year to claim the deduction.

Document properly: Keep records of plan adoption, contributions, and required filings (like Form 5500 for Solo 401(k)s).

The Double Benefit of Retirement Contributions

Not only do you lower your current year’s tax bill, but your contributions grow tax-deferred until you withdraw them in retirement—potentially decades from now. That’s more money working for you, instead of going to the IRS today.

Next Steps

If you’re a business owner looking to cut your tax bill and grow your retirement savings, now is the time to act. Schedule a one-on-one strategy session with our CPA to design the right retirement plan for your situation and maximize your deductions before year-end.