Diane Kennedy, CPA
1 min read
Many solopreneurs assume any income qualifies them for IRA contributions, but retirement plan rules are more nuanced. Understanding the difference between earned income, business profits, and deduction eligibility can help you avoid costly mistakes and maximize your retirement strategy.
Many solopreneurs assume that if they made money during the year, they can automatically contribute to an IRA or other retirement plan.
Unfortunately, retirement plan rules don't always work that way.
Over the years, I've had numerous conversations with business owners who were surprised to learn that income, retirement contributions, and retirement deductions don't all follow the same rules.
Here are three real-life examples that illustrate some of the most common misunderstandings.
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Take Quiz"But I Made Over $200,000"
A client called me last year convinced he could contribute to a Roth IRA.
"I made over $200,000," he told me.
So I asked where the income came from.
His answer included rental income, dividend and interest income, a Roth conversion, and a new sole proprietorship that actually had a loss.
That's when I needed to explain his problem.
For IRA purposes, the IRS generally looks for earned income. That's income that is subject to payroll tax or self-employment tax.
Many other types of income don't qualify, including rental income, dividends, interest, and capital gains.
When clients ask for a simple rule of thumb, I often tell them:
"If you're paying payroll tax or self-employment tax, you're usually in the earned-income neighborhood."
In this case, despite reporting more than $200,000 of total income, the client had little or no earned income available to support the IRA contribution he expected.
It's also important to remember that Roth IRA eligibility has its own income limitations. For 2026, Roth IRA contribution eligibility begins to phase out at modified adjusted gross income (MAGI) of $153,000 for single taxpayers and $242,000 for married taxpayers filing jointly.
"My Business Made $100,000"
Another common misunderstanding involves S corporations.
A solopreneur owned an S corporation that generated $100,000 of profit.
The owner paid themselves a W-2 salary of $40,000, with the remaining $60,000 flowing through on a Schedule K-1.
When it came time to establish a SEP-IRA, the owner assumed they could contribute the maximum 25% of the entire $100,000 business profit.
The reality was different.
For retirement plan purposes, the calculation is generally based on compensation, not total S corporation profit.
The $60,000 of K-1 income wasn't subject to payroll tax and therefore didn't count toward the retirement plan calculation.
Instead, the contribution limit was based on the $40,000 W-2 salary. In this example, the SEP-IRA contribution would generally be limited to approximately $10,000 rather than the $25,000 contribution the owner expected.
This misunderstanding is especially common among solopreneurs because many assume that all business profit counts equally for retirement planning purposes.
It doesn't.
If you're operating as an S Corp, understanding how compensation affects retirement contributions is critical. Many business owners focus solely on profit, but retirement plan limits often depend on wages rather than total business income.
"The Deduction Was The Problem"
A business owner called me after contributing to a Traditional IRA.
"I know I make too much for a Roth IRA," she said, "so I contributed to a Traditional IRA instead."
Her business was doing well, and her household income was comfortably into the six figures. Her spouse also participated in a retirement plan through work.
She assumed the contribution would generate a tax deduction.
The surprise?
The contribution wasn't the problem. The deduction was.
For 2026, a married taxpayer may still be eligible to make a Traditional IRA contribution even if a spouse participates in a workplace retirement plan.
However, the ability to deduct that contribution begins to phase out when modified adjusted gross income exceeds $242,000.
That's why retirement planning isn't just about whether you can contribute because you have earned income. That's important, but that's not all.
It's also about whether you receive the tax benefit you thought you were getting.
Earned Income And IRAs: Frequently Asked Questions (FAQs)
Can I Contribute To An IRA If My Income Comes From Rental Properties?
Generally, rental income does not count as earned income for IRA contribution purposes. Many real estate investors need wages or self-employment income from another source to qualify.
Does Dividend Or Interest Income Count As Earned Income?
No. Dividend income, interest income, and most capital gains are investment income, not earned income.
Can I Contribute To An IRA If My Business Loses Money?
It depends. IRA contributions are generally based on earned income. If your sole proprietorship reports a loss and you have no other earned income, your contribution options may be limited.
Does S Corporation Income Count For SEP-IRA Contributions?
Generally, retirement plan calculations for S corporation owners are based on W-2 wages rather than Schedule K-1 income. Business profits that pass through on a K-1 typically do not increase SEP contribution limits.
Can My Spouse's Retirement Plan Affect My IRA Deduction?
Yes. If your spouse participates in a workplace retirement plan, your ability to deduct a Traditional IRA contribution may be reduced or eliminated once household income reaches certain levels.
The Bottom Line on Earned Income and IRAs
Income, retirement contributions, and retirement deductions use different rules. Your circumstances may mean you pass one test, but not another.
Before funding an IRA, SEP-IRA, SIMPLE-IRA, or Solo 401(k), make sure you understand what income qualifies, how contribution limits are calculated, and whether any employee or spouse-related rules apply.
A quick conversation before making the contribution is usually much easier, and much less expensive, than fixing a mistake after the fact.
How Lettuce Can Help
Understanding earned income, S corporation compensation, retirement contribution limits, and tax deductions can be overwhelming for solopreneurs. Lettuce helps self-employed business owners simplify the financial side of running a business by automating key administrative tasks, including S corporation management, payroll, tax filings, bookkeeping support, and compliance tracking.
If you're earning consistent self-employment income, Lettuce can help you determine whether an S corporation election may reduce your tax burden, automate reasonable compensation calculations, and keep your business organized year-round so you can focus on growth.
Ready to take a more strategic approach to taxes and retirement planning? Try Lettuce and get started today!
This article is part of the Tax Strategy Series, featuring in-depth, practical guidance from Diane Kennedy, CPA—bestselling author, strategic tax consultant, and founder of USTaxAid and KennedyTax.tax. Explore the full series and catch every installment here.
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