A Solo 401(k) or SEP-IRA Could Cut Your 2026 Tax Bill: What Owners Should Know Before December 31

If you are self-employed, your retirement plan may be more than a way to save for the future. It may also be a valuable part of your 2026 tax strategy.

A Solo 401(k) or SEP-IRA can allow eligible business owners to contribute money on a tax-advantaged basis. Traditional contributions may reduce taxable income for 2026, potentially lowering the amount of federal income tax you owe.

However, the plans work differently. The contribution limits, deadlines, Roth options, and deduction rules can be easy to misunderstand, especially when you are both the employee and the employer.

If you are a sole proprietor, independent contractor, or owner of an LLC taxed as a sole proprietorship, here is what to review before year-end.

Important: This article provides general educational information, not individualized tax or investment advice. Your allowable contribution depends on factors such as your net self-employment income, business structure, age, other retirement plans, and the plan’s documents. Work with a qualified tax professional before making a contribution.

Why retirement contributions may reduce your 2026 tax bill

A traditional retirement contribution may reduce the income that is subject to federal income tax. In simple terms, if your business is profitable and you make an eligible traditional contribution, some of that income may be directed into a retirement account instead of being taxed currently.

The actual tax savings depend on your tax bracket and your complete tax situation. A contribution does not reduce your tax bill dollar-for-dollar. For example, a $10,000 deductible contribution does not automatically save $10,000 in taxes. Instead, it reduces taxable income by the amount you are allowed to deduct.

Retirement contributions may also help you:

• Build long-term retirement savings.

• Create a more consistent savings habit.

• Reduce the amount of income taxed at your current marginal tax rate.

• Make a strategic use of a profitable business year.

• Avoid waiting until tax season to think about retirement planning.

Before making a contribution, make sure your bookkeeping is current. Your allowable contribution is generally tied to your business’s net earnings, not simply your gross revenue or bank balance. Monthly bookkeeping can help you get a clearer picture of your profit before making a year-end decision.

Solo 401(k) vs. SEP-IRA: What is the basic difference?

Both plans can be useful for self-employed owners, but their contribution mechanics are different.

Solo 401(k): employee deferral plus employer contribution

A Solo 401(k), also called a one-participant 401(k), allows you to contribute in two roles:

1. Employee: You may make an elective deferral from your earned income.

2. Employer: Your business may make an additional contribution based on your business income.

This two-part structure is one of the main advantages of a Solo 401(k). It may allow a business owner with moderate net earnings to contribute more than would be possible through an employer-only plan.

The employee contribution may generally be made as either:

• A traditional, pre-tax contribution, or

• A designated Roth contribution, if the plan allows it.

Traditional employee deferrals can reduce current taxable income. Roth deferrals generally do not provide a current deduction, but qualified Roth withdrawals may be tax-free in retirement.

The employer contribution is generally made on a pre-tax basis.

A Solo 401(k) is designed for a business owner with no common-law employees other than a spouse. If you hire employees who become eligible to participate, the plan may no longer qualify as a “solo” arrangement and additional rules may apply.

The IRS guidance on one-participant 401(k) plans provides more detail.

SEP-IRA: employer-only contributions

A SEP-IRA is simpler in one important way: contributions are made by the employer. There are no employee elective deferrals.

For a self-employed owner, you are both the employer and the person receiving the contribution. However, the contribution is treated as an employer contribution based on your eligible self-employment income.

SEP-IRA contributions are generally traditional, pre-tax contributions. A SEP-IRA does not offer a designated Roth contribution option, and it does not provide separate employee deferrals or employee catch-up contributions.

The IRS SEP plan guidance explains the general requirements.

Contribution limits depend on your net earnings

You may see large annual contribution limits advertised for Solo 401(k)s and SEP-IRAs. Those figures are not automatically available to every business owner.

Your actual limit depends on factors such as:

• Net profit from self-employment.

• The deduction for one-half of self-employment tax.

• Your age.

• Contributions made to other employer retirement plans.

• Whether the contribution is an employee deferral or employer contribution.

• The plan’s terms.

• Annual IRS limits for the tax year.

For 2026, the employee elective deferral limit for a 401(k) is generally listed as $24,500, before applicable catch-up contributions. The overall annual additions limit for defined contribution plans is generally listed as $72,000, although your personal allowable contribution may be much lower because it is limited by your net earnings.

For a self-employed individual, the employer contribution is not simply 25% of gross business revenue. The calculation uses a special formula that takes self-employment tax and the contribution itself into account. The effective contribution rate is often closer to 20% of adjusted net earnings when the plan’s stated contribution rate is 25%.

The IRS Publication 560 worksheets for self-employed individuals should be used with care. This is one area where an incorrect calculation can create an excess contribution or an inaccurate deduction.

The deadline difference that matters most

The deadline is one of the most important differences between these plans.

Solo 401(k) deadline

If you want to make employee elective deferrals for 2026, a Solo 401(k) generally must be established by December 31, 2026 for a calendar-year business.

That means you should not wait until you prepare your 2026 tax return in 2027 to decide whether you want the employee-deferral feature. The plan generally needs to be in place by year-end, and the required election and contribution procedures must be followed.

Some rules may allow certain employer-only contributions for a newly established plan after year-end, depending on the circumstances. However, if your goal is to use both the employee and employer contribution features, treating December 31, 2026, as the practical setup deadline is the safer planning approach.

SEP-IRA deadline

A SEP-IRA generally offers more flexibility after the close of the tax year.

For a calendar-year self-employed taxpayer, a SEP-IRA can generally be established and funded by the due date of the 2026 tax return, including extensions. That may mean:

• April 15, 2027, if you file without an extension.

• October 15, 2027, if you file a valid extension.

This flexibility can be helpful when you need more time to finalize your business profit and determine how much you can afford to contribute.

However, waiting does not always make sense. You may want to make the decision earlier so you can budget for the contribution, invest the money appropriately, and avoid a last-minute tax planning scramble.

Traditional or Roth: Which direction makes sense?

A traditional contribution and a Roth contribution solve different tax-planning problems.

Traditional contributions

Traditional Solo 401(k) deferrals and SEP-IRA contributions are generally made before income tax. They may reduce current taxable income, subject to the applicable rules and limits.

A traditional contribution may be worth considering if:

• Your 2026 taxable income is higher than usual.

• You expect to be in a lower tax bracket during retirement.

• You want a current-year deduction.

• You have sufficient cash flow to make the contribution without disrupting operations.

Roth contributions

A Solo 401(k) may allow Roth employee deferrals. Roth contributions are made with after-tax dollars, so they generally do not reduce your 2026 taxable income.

The potential benefit comes later: qualified Roth withdrawals may be tax-free if applicable requirements are met.

A Roth strategy may be worth discussing if:

• You expect your future tax rate to be similar to or higher than your current rate.

• You want to diversify the tax treatment of your retirement savings.

• You are comfortable giving up the current deduction.

• You have a long investment horizon.

A SEP-IRA does not provide the same designated Roth contribution option. If Roth savings are important to your plan, a Solo 401(k) may provide more flexibility.

How do you claim the deduction?

For many self-employed owners, retirement plan contributions are not deducted as an ordinary business expense on Schedule C.

Instead, the deductible portion is generally reported on the appropriate individual income tax return schedule for self-employed retirement plan contributions. The exact reporting depends on your business structure, the type of contribution, and your tax return.

This distinction matters because recording a retirement contribution as a regular bookkeeping expense could distort your business profit and financial reports. Your books should accurately reflect the transaction, but the tax deduction may be claimed separately on your individual return.

Before filing, confirm:

• The contribution was made to the correct type of plan.

• The amount does not exceed your allowable limit.

• Traditional and Roth contributions are classified correctly.

• The contribution is reported on the proper tax forms.

• Any required plan documents or filings are complete.

What should you do before December 31?

If you are considering a Solo 401(k) or SEP-IRA for 2026, start with these steps:

Talk with Your Business Accountant before December 31

Retirement planning can be an effective part of a broader tax strategy, but the best choice depends on your business income, cash flow, tax bracket, retirement goals, and future plans.

At Your Business Accountant, we help small business owners understand their numbers, plan for taxes, and make informed financial decisions. We can review your bookkeeping, estimate your 2026 tax position, and help you identify questions to discuss with your retirement plan provider or financial professional.

Do not wait until tax season to discover that the plan you wanted needed to be established before year-end.

Schedule a tax planning consultation before December 31 so you can evaluate your options with clearer numbers and greater confidence.