Keogh or Sep IRA for Traders

Can a person with traders status, who does not trade within the form of any type of corporation instead is a self proprietorship, fund a Keogh or SEP Ira? I would ask about the defined benefit plan as well but I'm almost sure that you would need to form a corporation for that and generate revenue from trading in that business entity.
Thanks for the responses in advance.

 

You need earned income to contribute to a qualified retirement plan. Do you (or your spouse if married and filing jointly) have any wages? All your sole proprietorship trading profits will be capital gains on your Schedule D and you cannot contribute these to a retirement plan.

This is why GreenTaxTrader discusses forming an LLC on his website — just for the purpose of converting capital gains to earned income to contribute to a retirement plan.

Since I'm sure Joe Wishcamper will have some good advice also, here's a question for him...

What if a husband manages an account for his wife and gets paid a management fee for his services? Then this would be Sch. E self-employment earned income. The husband could then contribute to a retirement plan. What do you think, Joe? You can hire your kids, how about hiring your spouse??

 

Aaron my man. Nice answer thats exactly what I need to know. Basically I'm interested in this upcoming year 2004 of starting to stuff away like 15k per year in gross profits in to a Keogh going forward each year. Well now I have my answer. Looks like I am going to have to meet with my accountant about the llc. Thanks Aaron.

 

LLC is really cheap & easy to do, and you can basically divert as much or as little income as "salary" as you wish. It gives you a lot of flexibility in a lot of different tax areas. My wife is an "employee", providing "support and administrative services" and this allows her to put away IRA money as well. As always, talk to your accountant first, though!
Jessie

 

With an LLC, doesn't a trader have to pay social security and some other taxes?

Thanks,

Chinook

 

Yes.

 

To Aaron:

I certainly think you gave a good and correct answer to the basic question asked in the original post. Your own follow-up question is more interesting.

The issue you present is whether a management fee paid by the wife to the husband would constitute earned income sufficient to enable funding of an IRA or other retirement plan. Specifically, would such a management fee (upon which the husband then pays the 15.4% self-employment tax) constitute “net earnings from self-employment” under I.R.C. § 1402?

I assume this arises outside the context of an entity transaction, since your facts suggest the husband is simply going to manage the wife’s brokerage account in exchange for a management fee. If it is an entity arrangement, then disregard what I am about to write.

To begin with, the husband needs to have a “trade or business” in which he provides this "management-of-the-account” type service to others. If he has no other customers, you can see the IRS might challenge whether the husband actually has a bona fide business sufficient to support the definitional requirement in Code § 1402(a). This is really a threshold concern because if he doesn’t have a business, he doesn’t have self-employment income.

You can see the potential for complications here, Aaron. A trader has a trade or business in trading stock or securities for his OWN account. If he is trading for customers, then he is a “dealer” under I.R.C. § 475(c)(1), which is a different business. So the fact that the husband might have a business as a trader does not mean he also has a business managing the accounts of other people—and it is the latter hurdle he has to clear in your hypothetical.

If he gets past that hurdle, I think there is a different concern that arises if the husband and wife are residents of a community property state, or even a state with tenancy by the entirety. The community property regime (and perhaps also tenancy by the entirety, with which I am less familiar) creates a presumption that both spouses have co-ownership of any property acquired during marriage. So if this occurs in a community property state, the husband would essentially be deemed to be managing his own account even though it might be held in the wife’s name.

If he gets past all those hurdles, then I do not see any other technical prohibition that would prevent the husband from gaining “earned income” in the manner you suggest. But we all know that any transaction that is one of self-dealing comes under much greater scrutiny than an arm’s length transaction.

I haven’t had the opportunity to do any further research on this question, and given my exploding inbox, I don’t think I will have any such opportunity soon. So my conclusion is that your proposal is an aggressive strategy, and one should not be attempted unless (1) the trade or business requirement is met; and (2) there is no community property complication.

 

Thanks, Joe. You are always so thorough and knowledgeable in your work!

 

So, bottom line then, nearly all traders cannot put up an IRA unless he or she has another job from which they are paid an "earned income?" The LLC route would not work then? Is this right? Pardon me if I appear slow, but I want to be sure I understand this correctly. thx!

 

Hi I Missed the Boat:

No, I think you may have misunderstood my posting. I did not mean the LLC route will not work to generate earned income. To the contrary, I think it will.

My posting to Aaron was addressed solely at the hypothetical he presented, which was a situation where a husband manages his wife's brokerage account and takes a fee from it. There was no entity in that situation. I commented in my posting that I was not addressing the situation with entities, and I said, "If it is an entity arrangement, then disregard what I am about to write."