S Corporation with single owner/employee: salary vs. distribution with goal of maximizing retirement accounts

[vitalyocean]

Hi all,

I operate an S Corporation as the sole owner and employee. I've been paying myself a market salary (about $45k), as required by the IRS, and paying out the rest in non-dividend distributions. 100% of that salary component goes to 401k. However, it occurred to me recently that I should try to max out the $57,000 employee plus employer limit for my 401(k), as my goal is to contribute as much to my 401(k) as possible.

I previously favored paying myself as much as possible in distributions rather than salary to save on FICA taxes; however, my current rationale is the following: the FICA taxes, which I pay on salary, is 15.3%; whereas, the long term capital gains are taxed at 15%. So that difference of 0.3% is negligible, especially if you're like me and think that the long term capital gains tax rate will increase in the future. So I may as well contribute everything that I can to my 401(k) and pay those taxes now (I do in-plan rollovers to my Roth 401k such that 100% of my contributions are ultimately being made into the Roth, which is why I say that I'm paying taxes now). So my first question is: is my logic sound here?

My second question would be: if I pay myself $57,000 in salary and contribute 100% of it to 401k, and I want to contribute another $6k to my Roth IRA, do I need to actually pay myself $63,000 in salary?

Apologies if this isn't the right sub: please point me in the right direction, if that's the case!

Thanks so much for your time and responses!

 

[bprice]

@vitalyocean Crosspost this to /r/Tax

 

[vitalyocean]

@bprice Thanks and done!

https://www.reddit.com/r/tax/comments/hqi3rk/s_corporation_with_single_owneremployee_salary_vs

 

[liztaylor972]

@vitalyocean You can't compare the tax rates since they tax different bases. The FICA rate is applied to the full salary, the capital gains rate is applied to the amount of gains on invested capital - the math then is more complex than what you are doing here and will depend on many assumptions that you would want to model sensitivity around. You'd probably want to model it more completely too and include the question of whether you should be doing pre-tax or Roth contributions.

For IRA purposes, earned income is the amount in Box 1 of your W2 - since post-tax 401k contributions are reported as income in Box 1 you can use that as the basis for IRA contributions.

 

[613jono]

@vitalyocean This is a great question, I also wondered if you have an s Corp, shouldnt you have a SEP or Keough vs 401k?

 

[liztaylor972]

@613jono A 401k will allow you to contribute more than a SEP IRA and his solo 401k is a 'keogh' plan.

 

[championmicky]

@liztaylor972 Agree but you also need to consider the cost of managing each. It’s been a few years, but when I researched it a couple years ago, sep fees were considerably less then. Solo 401k

 

[vitalyocean]

@championmicky Good point! Today, at least, Solo 401k is free at least at all of the major online brokers. Fidelity even offers an option to automatically do in-plan rollovers from traditional to Roth 401k, which is neat! I use E*Trade because I wanted their loan feature: to be able to offer a loan from your 401k to yourself (up to 50-percent of the value of the account, or $50k -- whichever is the lesser dollar amount)

 

[fbg]

@championmicky Schwab has offered solo 401k plans with zero fees for at least a decade.

 

[liztaylor972]

@championmicky You can get a solo 401k free at most brokers and at most, depending on how much you have in it, you are talking about filing out a 5500 form once a year. And this was definitely true a couple of years ago too.

 

[vitalyocean]

@liztaylor972 Oh... thanks. I forgot to mention that I didn't know what a Keogh plan was, but you correctly determined that I have a Solo 401k, which TIL is a Keogh plan. Thanks!

 

[liztaylor972]

@vitalyocean 'Keogh' is really an anachronistic term from a time when the law treated plans of unincorporated entities differently.

 

[bobwhite]

@613jono I have a single member S corp/LLC with only contractors for employees and so I therefore have a 401k where I can put $19,200 per year for me personally and my company matches 25%. Once I'm married, because my husband works in the business I can put away the same amount for him with same match. Please ask your advisor about this. Can't be done if there are other w-2 employees.

Edit: oh I guess everyone else came here to say this first. Solo 401k is what it's called, looks like.

 

[vitalyocean]

@613jono I preferred 401k over SEP due to SEP maxes out contributions at 25-percent of salary. But if that isn't your concern, then you might be right!

 

[kellim]

@vitalyocean The maximum the business can contribute is 25% of your payroll (salary/bonus) up to $57k. The maximum an employee can contribute is $19,500, including business contributions cannot exceed $57,000.

If you do anything outside of this, it will immediately come up on your tax filings, regardless of an audit.

As to how much you pay yourself, someone else was correct with "you are supposed to pay yourself a fair and reasonable salary." The IRS is vague here because of the wide variety of scenarios that can exist. Most accountants will tell you the same as they do not want to be liable for an audit issue. The closest guidance I have received is this. Pay yourself what you would pay someone else to do your job based on industry standards or peers. However try to stay within 40-60% salary versus distribution range. 40k salary, 60k distribution. Don't go beyond those as you open yourself up to audit. It may take them 10 years to catch on, but they will come back to the first year of your mistake.

I am in a similar scenario being a single owner/employee S-Corp. The easiest way to deal with the distributions is to pay them to yourself through your payroll as a bonus. It is taxed the same, and taken out up front, so that you don't have to deal with the quarterly taxes or big lump sum at filing. Also, as a bonus that money counts towards the 401k contribution calculation, whereas a distribution does not.

To max out 401k contribution at $57,000 being 25% of compensation, you would need to make $228,000 between salary and bonus if paid entirely by the business.

To max out 401k contribution at $57,000 being 25% of compensation, you would need to make $150,000 between salary and bonus with the business contributing $37,500 and you contributing $19,500.

EDIT: Also, whatever percentage you pay yourself for retirement contributions has to match what you pay future employees too whenever they come on board. So plan to scale back or pay up whenever that happens.

EDIT 2: References - Publication 560

EDIT 3: I am not an expert, CPA or accountant. However this is a summation of the $20k I’ve spent on their advice between three different teams and a CFO advisor over the last 18 months.

EDIT 4: Also, I agree with the others that despite your interest in taxes you should still hire a CPA to do them for you. You’ll learn more in the process and you have less at risk considering the amount you would spend on paying someone to do it versus the consequences of screwing it up yourself. Case in point the question you’re posing here.

 

[kwintessenz]

@kellim OP needs to see this comment re the 25% rule. Also not a CPA, but got the same advice from my CPA when I told them I wanted to max out the 57k 401k contribution.

 

[liztaylor972]

@kwintessenz The 25% limit doesn't apply to the type of contributions the OP is making.

 

[kwintessenz]

@liztaylor972 Do you have a source? Would appreciate that.

 

[liztaylor972]

@kwintessenz Sure, this description is as good as any: https://www.fidelity.com/viewpoints/retirement/401k-contributions

 

[kwintessenz]

@liztaylor972 Interesting. So if you contribute to an after-tax 401k plan, you can technically contribute more than you earn after taxes? For example, in OP's case, I understand you're saying that he can contribute 57k to the after-tax 401k plan even though he only pays himself 57k (and therefore would not have 57k of after-tax money to contribute). Is that right? Just trying to understand this.