401k/taxable dilemma

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Topic Author
eltron
Posts: 148
Joined: Wed Apr 06, 2016 2:25 pm

401k/taxable dilemma

Post by eltron » Sun Nov 25, 2018 10:48 pm

Hi all.

I’m self employed, 35 y/o, married filing jointly and my wife is a stay at home mom. At my current trajectory, I’ll be in the 32% tax bracket for 2018.

I fund a solo 401k and max that out, I max out our HSA and do a backdoor Roth for both myself and my wife.

For 2019, I’m tossing around the idea of putting my wife on a W2 through my business and pay her $24k per year. This would allow her to open up her own solo 401k and contribute $18k to it and my business could contribute 25% of what she made ($6k) to sock away an additional $24k in retirement.

I’m already putting away $73k in retirement every year without doing this. My question is should I try to shoot for socking away this additional $24k.

The knee jerk answer would be definitely, sock away as much as you can and get every write off available to you. But at my tax bracket that money could very well be coming out at 32%+ when I retire. Whereas if I put the money into a taxable account, it would be coming out at capital gains rates (15%).

I understand rates can change so you can’t predict what rates will be 25 years from now, but let’s just assume rates will be relatively similar - would throwing that money into a taxable account and letting it sit there until retirement prove wiser than funding a second solo 401?

Also curious if anyone might know the tax write off I’d be looking at sheltering an additional $24k per year.

I’d like to look at early retirement (before 50) so obviously the taxable account seems more tempting to me currently.

Appreciate any feedback.

PFInterest
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Re: 401k/taxable dilemma

Post by PFInterest » Sun Nov 25, 2018 10:54 pm

If she is W2, how are you going to open a solo 401k?

Topic Author
eltron
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Re: 401k/taxable dilemma

Post by eltron » Sun Nov 25, 2018 11:06 pm

PFInterest wrote:
Sun Nov 25, 2018 10:54 pm
If she is W2, how are you going to open a solo 401k?
I guess I misread something. It was awhile ago I looked at it.

Now that you mention it I believe when I considered doing this a couple years back I suggested putting her on a 1099 and was told the IRS frowns on putting family members/spouses on a 1099.

So I guess I should restructure my question to - is opening a solo 401k for her even an option? Might make my decision a bit easier.

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FiveK
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Re: 401k/taxable dilemma

Post by FiveK » Mon Nov 26, 2018 2:36 am

eltron wrote:
Sun Nov 25, 2018 10:48 pm
The knee jerk answer would be definitely, sock away as much as you can and get every write off available to you. But at my tax bracket that money could very well be coming out at 32%+ when I retire. Whereas if I put the money into a taxable account, it would be coming out at capital gains rates (15%).
If you think your retirement marginal rate will be that high, some solo 401k providers offer a Roth option. See Solo 401(k) plan - Bogleheads for more.

Note that it would take ~$8 million in traditional accounts to hit the 32% bracket using a 4% withdrawal rate, if that is your only income.

Topic Author
eltron
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Re: 401k/taxable dilemma

Post by eltron » Mon Nov 26, 2018 7:40 am

FiveK wrote:
Mon Nov 26, 2018 2:36 am
eltron wrote:
Sun Nov 25, 2018 10:48 pm
The knee jerk answer would be definitely, sock away as much as you can and get every write off available to you. But at my tax bracket that money could very well be coming out at 32%+ when I retire. Whereas if I put the money into a taxable account, it would be coming out at capital gains rates (15%).
If you think your retirement marginal rate will be that high, some solo 401k providers offer a Roth option. See Solo 401(k) plan - Bogleheads for more.

Note that it would take ~$8 million in traditional accounts to hit the 32% bracket using a 4% withdrawal rate, if that is your only income.
My goal is $4 million. Whether or not I can hit that in retirement accounts is another story if I plan on early retirement. Do you know where I could find what the marginal tax rate would be for that amount?

And, again, going off what PFInterest said, I’m not even sure I can go the solo route with my wife if I go the W2 route. Not sure if it’s worth the trouble setting up some other retirement fund for her.

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FiveK
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Re: 401k/taxable dilemma

Post by FiveK » Mon Nov 26, 2018 7:50 am

eltron wrote:
Mon Nov 26, 2018 7:40 am
My goal is $4 million. Whether or not I can hit that in retirement accounts is another story if I plan on early retirement. Do you know where I could find what the marginal tax rate would be for that amount?
$4 million * 4% = $160K.
For MFJ standard deduction, $160K - $24K = $136K

$136K is in the 22% bracket for MFJ.

See Investment Order for a somewhat more accurate way to estimate your retirement marginal tax rate.
And, again, going off what PFInterest said, I’m not even sure I can go the solo route with my wife if I go the W2 route. Not sure if it’s worth the trouble setting up some other retirement fund for her.
Was the wiki entry (and links therein) helpful?

NightFall
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Re: 401k/taxable dilemma

Post by NightFall » Mon Nov 26, 2018 8:02 am

I think you have a misunderstanding of how taxes work. While money in a taxable account comes out at 15% or 20%, there is likely tax drag along the way. In addition, that money was taxed when you put it in. So 32% less money would go into taxable than your traditional account. Even if tax rates are the same later and the money comes out at 32%, you pay an extra 15-20% on the gains with a taxable account than you do on traditional. Multiplication is commutative.

retiredjg
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Re: 401k/taxable dilemma

Post by retiredjg » Mon Nov 26, 2018 8:14 am

eltron wrote:
Sun Nov 25, 2018 10:48 pm
But at my tax bracket that money could very well be coming out at 32%+ when I retire.
This is not impossible, but it is less usual than one might think. There is a very big difference between being wealthy in retirement and being in a high tax bracket. In fact, many wealthy people are in low tax brackets in retirement.

Unless you have a specific reason to think otherwise, this might be something you should look at more carefully.

Topic Author
eltron
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Re: 401k/taxable dilemma

Post by eltron » Mon Nov 26, 2018 8:28 am

FiveK wrote:
Mon Nov 26, 2018 7:50 am
eltron wrote:
Mon Nov 26, 2018 7:40 am
My goal is $4 million. Whether or not I can hit that in retirement accounts is another story if I plan on early retirement. Do you know where I could find what the marginal tax rate would be for that amount?
$4 million * 4% = $160K.
For MFJ standard deduction, $160K - $24K = $136K

$136K is in the 22% bracket for MFJ.

See Investment Order for a somewhat more accurate way to estimate your retirement marginal tax rate.
And, again, going off what PFInterest said, I’m not even sure I can go the solo route with my wife if I go the W2 route. Not sure if it’s worth the trouble setting up some other retirement fund for her.
Was the wiki entry (and links therein) helpful?
Thanks for posting, will check the links out tonight.

Topic Author
eltron
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Joined: Wed Apr 06, 2016 2:25 pm

Re: 401k/taxable dilemma

Post by eltron » Mon Nov 26, 2018 8:32 am

NightFall wrote:
Mon Nov 26, 2018 8:02 am
I think you have a misunderstanding of how taxes work. While money in a taxable account comes out at 15% or 20%, there is likely tax drag along the way. In addition, that money was taxed when you put it in. So 32% less money would go into taxable than your traditional account. Even if tax rates are the same later and the money comes out at 32%, you pay an extra 15-20% on the gains with a taxable account than you do on traditional. Multiplication is commutative.
You are correct, thanks for pointing that out. I was aware of the tax drag with a taxable, but I think I'm looking at this situation with a bit of tunnel vision (hence for outside, unbiased opinions).

I'm so heavily tilted towards wanting to start putting away a lot of money into a taxable so I can start looking towards early retirement that I'm not looking at the tax implications by going in that route.

To be clear, I'm still going to be maxing out everything on my end (solo, HSA, Roth), but I can't help to shake the feeling that as a self employed individual there is still more I could be doing, i.e. employ my wife and set up a retirement account for her. I'm just trying to figure out the best way to do that. As I said before, I initially was looking at doing a 1099 to set up a solo for her back in 2017 but was quickly told the IRS frowns on 1099'ing a spouse and the last thing I want to do is do extra work just to get popped by the IRS. So that leaves me with doing a W2 for her. I still need to do some research what my retirement options are for her if I pay her $24k a year via a W2.

ThriftyPhD
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Re: 401k/taxable dilemma

Post by ThriftyPhD » Mon Nov 26, 2018 10:04 am

eltron wrote:
Sun Nov 25, 2018 11:06 pm
PFInterest wrote:
Sun Nov 25, 2018 10:54 pm
If she is W2, how are you going to open a solo 401k?
I guess I misread something. It was awhile ago I looked at it.

Now that you mention it I believe when I considered doing this a couple years back I suggested putting her on a 1099 and was told the IRS frowns on putting family members/spouses on a 1099.

So I guess I should restructure my question to - is opening a solo 401k for her even an option? Might make my decision a bit easier.
I have not done this, but it seems like your spouse might be allowed to use the solo 401k?

https://www.irs.gov/retirement-plans/on ... 401k-plans
The one-participant 401(k) plan isn't a new type of 401(k) plan. It's a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. These plans have the same rules and requirements as any other 401(k) plan.
It might be worth exploring if your current solo 401k would work for your wife as well.

bdpb
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Joined: Wed Jun 06, 2007 3:14 pm

Re: 401k/taxable dilemma

Post by bdpb » Mon Nov 26, 2018 5:04 pm

Won't you be paying an extra 15% in FICA taxes?

Topic Author
eltron
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Re: 401k/taxable dilemma

Post by eltron » Mon Nov 26, 2018 6:10 pm

bdpb wrote:
Mon Nov 26, 2018 5:04 pm
Won't you be paying an extra 15% in FICA taxes?
I believe Nightfall addressed this and I agreed with him. The money will be taxed initially with SS, Medicare, etc. and then taxed again on removal. Obviously the smart money thing to do is find a way to create a separate retirement account for my wife and fund that as I initially posed.

My dilemma is, and has been, being happy with my current trajectory towards retirement and start funding a taxable account to help aid early retirement. I understand this is not the smart money thing to do, but would help me achieve my early retirement quicker.

What I'm, again, trying to find out from the community is - if paying my wife via a W2, what would be the best option for a retirement fund for her based off of my specific scenario.

niceguy7376
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Re: 401k/taxable dilemma

Post by niceguy7376 » Mon Nov 26, 2018 7:22 pm

To get better calculations, need more info

1. is your business structured as S Corp or Sole Prop?
2. What is the revenue generated in this model before your current salary
3. What is the salary that you were taking right now?

bdpb
Posts: 1567
Joined: Wed Jun 06, 2007 3:14 pm

Re: 401k/taxable dilemma

Post by bdpb » Mon Nov 26, 2018 7:44 pm

eltron wrote:
Mon Nov 26, 2018 6:10 pm
bdpb wrote:
Mon Nov 26, 2018 5:04 pm
Won't you be paying an extra 15% in FICA taxes?
I believe Nightfall addressed this and I agreed with him. The money will be taxed initially with SS, Medicare, etc. and then taxed again on removal. Obviously the smart money thing to do is find a way to create a separate retirement account for my wife and fund that as I initially posed.

My dilemma is, and has been, being happy with my current trajectory towards retirement and start funding a taxable account to help aid early retirement. I understand this is not the smart money thing to do, but would help me achieve my early retirement quicker.

What I'm, again, trying to find out from the community is - if paying my wife via a W2, what would be the best option for a retirement fund for her based off of my specific scenario.
I'm not sure you understood my point (at least I don't see any reference to FICA taxes in Nightfall's posts that seem to address this).

When you pay your wife an income, FICA taxes (employer and employee) need to be paid on the wages before any of it can be saved in a 401k. This is in addition to income taxes. Effectively, her marginal rate is 32% plus ~15%. Although, there may be some benefits gained from the FICA taxes paid.

Spirit Rider
Posts: 11883
Joined: Fri Mar 02, 2007 2:39 pm

Re: 401k/taxable dilemma

Post by Spirit Rider » Mon Nov 26, 2018 8:05 pm

I would point out that you can not just "pay" your wife a W-2 salary. She has to "earn" it by providing business necessary tasks in the number of hours and at a Fair Market Value (FMV) wage commensurate with the tasks performed.

Not to mention that the 2018 employee elective contribution limit is $18,500 not $18,000 and would require $18,500 employee deferral + $6,167 employer contribution = $24,667 in W-2 Salary. Assuming you paid $25/hour a pretty high rate for administrative tasks you would still have to pay her for 1,000 hours of work.

More importantly, W-2 employee deferrals can not come before a signed employee elective contribution election and must be deducted from compensation not already received with a pay date on or before 12/31.

Luckily, if you do not have an LLC in a non-community property state. You can elect to have the sole proprietorship treated as a Qualified Joint Venture (QJV), see the IRS Schedule C Instructions. You elect this by simply allocating the businesses income and expenses onto separate Schedule C and resulting Schedule SE for each one of you when you file your tax return.

You have to have a plausible case that she met the "material participation" requirements. The easiest one of these is that she performed 500 hours of tasks the sh was the predominate/only one doing those tasks. This easily be accomplished with administrative tasks that she can be primarily responsible for. The beauty of this is that once she has met the threshold you can allocate the net self-employment earnings between you by agreement (I suggest in writing)

The numbers can get a little tricky at lower levels. She is going to have to pay 15.3% SE taxes, but you would only be paying 2.9% SE taxes + if you are in the 32% bracket, you will be paying the 0.9% additional Medicare tax. You will be paying 11.5% more than you would. To make the biggest bang for your SE taxes, you will want 100% of her net self-employment earnings to go to pre-tax contributions. At lower levels of net self-employment earnings, the fact that self-employed employer contributions reduce compensation no more than 60% of net self-employment earnings can be employee elective contributions. So ideally you need her net self-employment earnings to be = $18,500 / 0.60 >= $30,833. which would require $33,177 in her business profits.

Note: The new section 199A might through in another complication. If your business is a Specified Service Trade or Business (SSTB) and you are in the 32% tax bracket that is in the phaseout range for the new QBI deduction. If you set the QJV allocation to give her $33,177 business profits that will result in a $2,344 1/2 SE tax deduction for a total in $35,521 adjustments to gross income. If that still leaves your taxable income before thee QBI deduction > $315K, you can simply increase her QJV allocation.

I am doing the numbers off of the top of my head and a preliminary understanding of the QBI deduction. This is all new to us and my understanding or math may be off (there are a lot of moving parts). The advantage of the (QJV) is that you can do it as "what ifs" in tax return software. You change the two Schedule Cs and every thing else should calculate.

P.S. She does not adopt her own one-participant 401k plan. She simply opens an account under your current plan. She should also do a Backdoor Roth if she doesn't have any pre-tax balances in traditional, SEP and SIMPLE IRA accounts. She can still do it if your one-participant 401k plan (not Vanguard) accepts IRA rollovers and she rolls over the pre-tax balance by 12/31 of the year of the Roth conversion.
Last edited by Spirit Rider on Mon Nov 26, 2018 8:18 pm, edited 1 time in total.

Spirit Rider
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Re: 401k/taxable dilemma

Post by Spirit Rider » Mon Nov 26, 2018 8:08 pm

niceguy7376 wrote:
Mon Nov 26, 2018 7:22 pm
To get better calculations, need more info

1. is your business structured as S Corp or Sole Prop?
2. What is the revenue generated in this model before your current salary
3. What is the salary that you were taking right now?
eltron wrote:
Sun Nov 25, 2018 10:48 pm
Hi all.

I’m self employed, 35 y/o, married filing jointly and my wife is a stay at home mom.

niceguy7376
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Joined: Wed Jul 10, 2013 2:59 pm
Location: Metro ATL

Re: 401k/taxable dilemma

Post by niceguy7376 » Mon Nov 26, 2018 8:45 pm

Spirit Rider wrote:
Mon Nov 26, 2018 8:08 pm
niceguy7376 wrote:
Mon Nov 26, 2018 7:22 pm
To get better calculations, need more info

1. is your business structured as S Corp or Sole Prop?
2. What is the revenue generated in this model before your current salary
3. What is the salary that you were taking right now?
eltron wrote:
Sun Nov 25, 2018 10:48 pm
Hi all.

I’m self employed, 35 y/o, married filing jointly and my wife is a stay at home mom.
Self Employed can either be S Corp or Sole Prop.
OP never said that they are maximizing the 52K that they can contribute to a 401k

Spirit Rider
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Joined: Fri Mar 02, 2007 2:39 pm

Re: 401k/taxable dilemma

Post by Spirit Rider » Mon Nov 26, 2018 9:07 pm

niceguy7376 wrote:
Mon Nov 26, 2018 8:45 pm
Spirit Rider wrote:
Mon Nov 26, 2018 8:08 pm
niceguy7376 wrote:
Mon Nov 26, 2018 7:22 pm
To get better calculations, need more info

1. is your business structured as S Corp or Sole Prop?
2. What is the revenue generated in this model before your current salary
3. What is the salary that you were taking right now?
eltron wrote:
Sun Nov 25, 2018 10:48 pm
Hi all.

I’m self employed, 35 y/o, married filing jointly and my wife is a stay at home mom.
Self Employed can either be S Corp or Sole Prop. OP never said that they are maximizing the 52K that they can contribute to a 401k
A self-employed individual is only a sole-proprietor or a partner in a partnership. An S-Corp shareholder-employee is most definitely not self-employed. A corporation and self-employment are mutually exclusive.

Don't be confused by the fact that if there are only owners and optionally their spouses, an S-Corp can adopt, maintain and contribute to a one-participant 401k just like a self-employed individual.
eltron wrote:
Sun Nov 25, 2018 10:48 pm
I fund a solo 401k and max that out, I max out our HSA and do a backdoor Roth for both myself and my wife. I’m already putting away $73k in retirement every year without doing this.
The 2018 annual addition limit is $55K. From my math that is $55K + $6,900 + $11K ~= $73K.

Topic Author
eltron
Posts: 148
Joined: Wed Apr 06, 2016 2:25 pm

Re: 401k/taxable dilemma

Post by eltron » Tue Nov 27, 2018 7:13 am

niceguy7376 wrote:
Mon Nov 26, 2018 8:45 pm
Spirit Rider wrote:
Mon Nov 26, 2018 8:08 pm
niceguy7376 wrote:
Mon Nov 26, 2018 7:22 pm
To get better calculations, need more info

1. is your business structured as S Corp or Sole Prop?
2. What is the revenue generated in this model before your current salary
3. What is the salary that you were taking right now?
eltron wrote:
Sun Nov 25, 2018 10:48 pm
Hi all.

I’m self employed, 35 y/o, married filing jointly and my wife is a stay at home mom.
Self Employed can either be S Corp or Sole Prop.
OP never said that they are maximizing the 52K that they can contribute to a 401k
Spirit Rider wrote:
Mon Nov 26, 2018 8:05 pm
I would point out that you can not just "pay" your wife a W-2 salary. She has to "earn" it by providing business necessary tasks in the number of hours and at a Fair Market Value (FMV) wage commensurate with the tasks performed.

Not to mention that the 2018 employee elective contribution limit is $18,500 not $18,000 and would require $18,500 employee deferral + $6,167 employer contribution = $24,667 in W-2 Salary. Assuming you paid $25/hour a pretty high rate for administrative tasks you would still have to pay her for 1,000 hours of work.

More importantly, W-2 employee deferrals can not come before a signed employee elective contribution election and must be deducted from compensation not already received with a pay date on or before 12/31.

Luckily, if you do not have an LLC in a non-community property state. You can elect to have the sole proprietorship treated as a Qualified Joint Venture (QJV), see the IRS Schedule C Instructions. You elect this by simply allocating the businesses income and expenses onto separate Schedule C and resulting Schedule SE for each one of you when you file your tax return.

You have to have a plausible case that she met the "material participation" requirements. The easiest one of these is that she performed 500 hours of tasks the sh was the predominate/only one doing those tasks. This easily be accomplished with administrative tasks that she can be primarily responsible for. The beauty of this is that once she has met the threshold you can allocate the net self-employment earnings between you by agreement (I suggest in writing)

The numbers can get a little tricky at lower levels. She is going to have to pay 15.3% SE taxes, but you would only be paying 2.9% SE taxes + if you are in the 32% bracket, you will be paying the 0.9% additional Medicare tax. You will be paying 11.5% more than you would. To make the biggest bang for your SE taxes, you will want 100% of her net self-employment earnings to go to pre-tax contributions. At lower levels of net self-employment earnings, the fact that self-employed employer contributions reduce compensation no more than 60% of net self-employment earnings can be employee elective contributions. So ideally you need her net self-employment earnings to be = $18,500 / 0.60 >= $30,833. which would require $33,177 in her business profits.

Note: The new section 199A might through in another complication. If your business is a Specified Service Trade or Business (SSTB) and you are in the 32% tax bracket that is in the phaseout range for the new QBI deduction. If you set the QJV allocation to give her $33,177 business profits that will result in a $2,344 1/2 SE tax deduction for a total in $35,521 adjustments to gross income. If that still leaves your taxable income before thee QBI deduction > $315K, you can simply increase her QJV allocation.

I am doing the numbers off of the top of my head and a preliminary understanding of the QBI deduction. This is all new to us and my understanding or math may be off (there are a lot of moving parts). The advantage of the (QJV) is that you can do it as "what ifs" in tax return software. You change the two Schedule Cs and every thing else should calculate.

P.S. She does not adopt her own one-participant 401k plan. She simply opens an account under your current plan. She should also do a Backdoor Roth if she doesn't have any pre-tax balances in traditional, SEP and SIMPLE IRA accounts. She can still do it if your one-participant 401k plan (not Vanguard) accepts IRA rollovers and she rolls over the pre-tax balance by 12/31 of the year of the Roth conversion.
A few things. My CPA has me set up as an S corp. I pay myself very little for tax purposes ($36k per year via W2 from my business). The vast majority of my income comes from my monthly distributions from the business at the end of the month where I take the profit left over from the business.

With that being said, speaking to Spirit Rider's very thorough and informative post, I've gleaned this much - I'm not about to learn all this new info, jump through all these hoops to open something (an additional solo 401k for my wife) that I'm still not even sure I legally can and if the benefits would prove worthy of my time. I have her do a Backdoor Roth yearly, so she at least has that.

I just feel that my best bet moving forward is to stick to business as usual, i.e. max out my solo 401k ($55k for 2018), HSA ($6900) and his/her backdoor Roths ($11,000). Anything additional I'm just going to toss into a taxable account.

Should the mood strike me in a year or two to revisit this and see if there are any easier ways to shelter more money through my spouse, this forum will be the first to know.

Thanks again for all the advice and showing me how in over my head I am when it comes to anything outside of my 'safe space' of my retirement funds.

niceguy7376
Posts: 2459
Joined: Wed Jul 10, 2013 2:59 pm
Location: Metro ATL

Re: 401k/taxable dilemma

Post by niceguy7376 » Tue Nov 27, 2018 11:44 am

eltron wrote:
Tue Nov 27, 2018 7:13 am
A few things. My CPA has me set up as an S corp. I pay myself very little for tax purposes ($36k per year via W2 from my business). The vast majority of my income comes from my monthly distributions from the business at the end of the month where I take the profit left over from the business.
I just feel that my best bet moving forward is to stick to business as usual, i.e. max out my solo 401k ($55k for 2018), HSA ($6900) and his/her backdoor Roths ($11,000). Anything additional I'm just going to toss into a taxable account.
Could you please let us know how you are able to put 55K into solo 401k with just 36K salary?

Spirit Rider
Posts: 11883
Joined: Fri Mar 02, 2007 2:39 pm

Re: 401k/taxable dilemma

Post by Spirit Rider » Tue Nov 27, 2018 1:23 pm

niceguy7376 wrote:
Tue Nov 27, 2018 11:44 am
eltron wrote:
Tue Nov 27, 2018 7:13 am
A few things. My CPA has me set up as an S corp. I pay myself very little for tax purposes ($36k per year via W2 from my business). The vast majority of my income comes from my monthly distributions from the business at the end of the month where I take the profit left over from the business.
I just feel that my best bet moving forward is to stick to business as usual, i.e. max out my solo 401k ($55k for 2018), HSA ($6900) and his/her backdoor Roths ($11,000). Anything additional I'm just going to toss into a taxable account.
Could you please let us know how you are able to put 55K into solo 401k with just 36K salary?
Exactly, the maximum employer contribution on $36K * 25% would be $9K + $18.5K = $27.5K. Distributions are not compensation and can never be used as the basis for retirement plan contributions. This is a massive excess employer contribution if already made this year. Excess employer contributions generally can not be returned, are subject to a 10% excise tax and require the 401k plan to file a Form 5330 for a minimum to two years or until the excess is reconciled with future contribution space.

Further more, like Form 5329, there is no Statute Of Limitations (SOL) on filing Form 5330. The excise tax accrues every year util reconciled with new contribution space. Also, the OP would need to go back to the very first year of excess contributions and file a Form 5330 for each year with the excess balance and excise taxes accumulating.

Not to mention, that the OP stated he was in the 32% tax bracket (2018 = $315,001 to $400,000). This implies he is paying himself a salary of around 10%, improper employer contributions of 10% and distributions of 80%. There is no possible way that this could be considered "reasonable salary" under IRS guidance. There is a 100% penalty on FICA payments not made due to unreasonably low salary. This is significant enough that is could possibly extend the SOL to six years. Either there is some misinformation here or the CPA is incompetent and/or encourages tax fraud.

If the OP has already made the $55K - $18.5K = $36.5 in employer contributions. He can solve both problems by paying himself at least $36.5K / 25% = $146K in W-2 wages. $340K net business profit - $146K salary - ~$11K employer share of FICA - ~$0.5K unemployment insurance - $36.5K 401k employer contribution = $146K distribution. $146K salary and $146K distribution = reasonable salary.

Hopefully, this is the OP's first year as an S-Corp and he dos not have the headache of retroactively filing Form 5330s and paying excise taxes.

Topic Author
eltron
Posts: 148
Joined: Wed Apr 06, 2016 2:25 pm

Re: 401k/taxable dilemma

Post by eltron » Tue Nov 27, 2018 2:11 pm

niceguy7376 wrote:
Tue Nov 27, 2018 11:44 am
eltron wrote:
Tue Nov 27, 2018 7:13 am
A few things. My CPA has me set up as an S corp. I pay myself very little for tax purposes ($36k per year via W2 from my business). The vast majority of my income comes from my monthly distributions from the business at the end of the month where I take the profit left over from the business.
I just feel that my best bet moving forward is to stick to business as usual, i.e. max out my solo 401k ($55k for 2018), HSA ($6900) and his/her backdoor Roths ($11,000). Anything additional I'm just going to toss into a taxable account.
Could you please let us know how you are able to put 55K into solo 401k with just 36K salary?
Spirit Rider wrote:
Tue Nov 27, 2018 1:23 pm
niceguy7376 wrote:
Tue Nov 27, 2018 11:44 am
eltron wrote:
Tue Nov 27, 2018 7:13 am
A few things. My CPA has me set up as an S corp. I pay myself very little for tax purposes ($36k per year via W2 from my business). The vast majority of my income comes from my monthly distributions from the business at the end of the month where I take the profit left over from the business.
I just feel that my best bet moving forward is to stick to business as usual, i.e. max out my solo 401k ($55k for 2018), HSA ($6900) and his/her backdoor Roths ($11,000). Anything additional I'm just going to toss into a taxable account.
Could you please let us know how you are able to put 55K into solo 401k with just 36K salary?
Exactly, the maximum employer contribution on $36K * 25% would be $9K + $18.5K = $27.5K. Distributions are not compensation and can never be used as the basis for retirement plan contributions. This is a massive excess employer contribution if already made this year. Excess employer contributions generally can not be returned, are subject to a 10% excise tax and require the 401k plan to file a Form 5330 for a minimum to two years or until the excess is reconciled with future contribution space.

Further more, like Form 5329, there is no Statute Of Limitations (SOL) on filing Form 5330. The excise tax accrues every year util reconciled with new contribution space. Also, the OP would need to go back to the very first year of excess contributions and file a Form 5330 for each year with the excess balance and excise taxes accumulating.

Not to mention, that the OP stated he was in the 32% tax bracket (2018 = $315,001 to $400,000). This implies he is paying himself a salary of around 10%, improper employer contributions of 10% and distributions of 80%. There is no possible way that this could be considered "reasonable salary" under IRS guidance. There is a 100% penalty on FICA payments not made due to unreasonably low salary. This is significant enough that is could possibly extend the SOL to six years. Either there is some misinformation here or the CPA is incompetent and/or encourages tax fraud.

If the OP has already made the $55K - $18.5K = $36.5 in employer contributions. He can solve both problems by paying himself at least $36.5K / 25% = $146K in W-2 wages. $340K net business profit - $146K salary - ~$11K employer share of FICA - ~$0.5K unemployment insurance - $36.5K 401k employer contribution = $146K distribution. $146K salary and $146K distribution = reasonable salary.

Hopefully, this is the OP's first year as an S-Corp and he dos not have the headache of retroactively filing Form 5330s and paying excise taxes.
This crossed my mind as I was typing it and I've already emailed my CPA about this.

To say I'm a little bit concerned (angry) is an understatement. Really hoping he has a good response for me.

harvestbook
Posts: 697
Joined: Sat Mar 18, 2017 7:12 pm

Re: 401k/taxable dilemma

Post by harvestbook » Tue Nov 27, 2018 2:19 pm

My understanding is if the S-Corp pays health insurance and HSAs, those are included in box 1 compensation and eligible for a 25 percent employer match, but it's hard to see how that adds $19K of space. If over 55, you get the $6,000 catchup contribution and an additional $1,500 employee match, so maybe that's getting in the ballpark.

You might want to ask this, too. I am in a similar boat and my accountant was pretty firm on the appropriate W-2 salary, which was ameliorated somewhat by my wife actually performing vital business tasks.
I'm not smart enough to know, and I can't afford to guess.

Spirit Rider
Posts: 11883
Joined: Fri Mar 02, 2007 2:39 pm

Re: 401k/taxable dilemma

Post by Spirit Rider » Tue Nov 27, 2018 4:20 pm

harvestbook wrote:
Tue Nov 27, 2018 2:19 pm
My understanding is if the S-Corp pays health insurance and HSAs, those are included in box 1 compensation and eligible for a 25 percent employer match, but it's hard to see how that adds $19K of space. If over 55, you get the $6,000 catchup contribution and an additional $1,500 employee match, so maybe that's getting in the ballpark.
Yes, S-Corp paid or reimbursed health insurance is treated as compensation and would increase available employer contribution space, but I agree this might at most add $4K - $6K in employer contributions.

The OP stated he is 35 in the first post and anyways the catch-up contributions must be employee elective contributions and do not increase the available employer contributions.

Topic Author
eltron
Posts: 148
Joined: Wed Apr 06, 2016 2:25 pm

Re: 401k/taxable dilemma

Post by eltron » Tue Nov 27, 2018 7:51 pm

Still waiting on my CPA's reply, but in the meantime it got me to thinking.

Earlier in the post PFInterest stated my wife would be unable to fund a solo 401k because she would be a W2 employee. The 36k salary I mentioned is my W2 pay. How is that amount relevant when funding a solo 401k but at the same time my wife, who would be on a W2 as mentioned earlier, would not be eligible to fund one because she was on a W2.

I guess I'm just confused as to how a W2 would preclude my wife from funding a solo 401k, but the income I make from my W2 is what is being looked at when funding mine.

Pardon my ignorance, but as I mentioned earlier, I'm big on saving but the more intricate stuff is over my head - hence me paying a CPA to do his job correctly.

Spirit Rider
Posts: 11883
Joined: Fri Mar 02, 2007 2:39 pm

Re: 401k/taxable dilemma

Post by Spirit Rider » Tue Nov 27, 2018 8:46 pm

It is often stated that one-participant 401k plan employers can not have employees without mentioning that spouses are an exception.

I don't think PFInterest was referring to the fact that she would have W-2 wages, rather was not aware that exception.

All that is necessary for a spouse to contribute to the business's one-participant 401k plan is for them to have compensation. This can either be W-2 wages or self-employment income as appropriate.

jacoavlu
Posts: 762
Joined: Sun Jan 06, 2013 12:06 pm

Re: 401k/taxable dilemma

Post by jacoavlu » Tue Nov 27, 2018 10:08 pm

eltron, is this your first year as an S Corp?

Regarding saving taxes. I almost hesitate to mention it because you need to sort out present issues before considering any future tax strategy. But your level of income may be able to support a defined benefit plan in addition to a 401k-Profit sharing plan. Defined benefit plans can allow additional deferral of significant levels of income, though are better when you’re older. Schwab offers a personal defined benefit plan for a reasonable cost.

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