Individual 401K Contribution Questions

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clayr361
Posts: 20
Joined: Tue Aug 19, 2014 2:48 pm

Individual 401K Contribution Questions

Post by clayr361 » Wed Sep 17, 2014 1:56 pm

I am an independent contractor and just set up an individual 401K (with Vanguard of course). I realize I can contribute 17.5K + employer contribution of 25%. I only pay myself 24K a year. So in theory I could contribute the 17.5K + 6K employer match to equal $23,500. My question is IF I do not contribute up to this amount does it matter what percentage of each I contribute. For example If I wanted to contribute 12K total. Should I go 6k personal and 6k employer match or 12K personal, or does it even matter at all? I talked to a representative from Vanguard about contributions and according to him they all come out of the same bank account (my company) you just specify if they are individual or company contributions. Would there be any end of year tax implications for contributing more from personal than company or vice versa? Are there any problems with my contribution figures above?
Last edited by clayr361 on Wed Sep 17, 2014 3:20 pm, edited 1 time in total.

ERISA Stone
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Joined: Tue Jun 24, 2014 8:54 am

Re: Individual 401K Contribution Questions

Post by ERISA Stone » Wed Sep 17, 2014 2:09 pm

I would allocate all funds up to $17,500 as a 401(k) contribution (EE contribution). That way, you don't have to worry about the 25% limit (only applies to ER contributions).

I don't believe there is a tax advantage to one vs. the other but maybe someone could confirm that for you.

knswamy
Posts: 57
Joined: Wed Sep 10, 2014 11:18 am

Re: Individual 401K Contribution Questions

Post by knswamy » Wed Sep 17, 2014 2:47 pm

OP, are you an S-corp or do you file with your personal income taxes? The ER contributions are exempt from payroll and SS if you are a corp, but then again they would be so even if you got a dividend rather than a 401(k) contribution, so not sure that makes a difference.

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

Re: Individual 401K Contribution Questions

Post by Spirit Rider » Wed Sep 17, 2014 3:03 pm

Generally, for an Individual 401K the employer contribution is a non elective profit sharing contribution and not an elective match. From a purely tax point of view it does not matter whether pre-tax contributions are from employee deferrals or employer contributions. The only difference would be if some or all of the employee deferral is a Roth contribution. In that case the Roth contribution is not deductible.

However, I mostly want to comment on something else. From your description of paying yourself, I assume you are either a corporation (likely with an S-Corp election), or an LLC with an S-Corp election. The mention of $24K sends up a big red flag to me and probably the IRS. Please tell me that your business net profit is < $50K. A fixed salary allotment of $2K a month used to be a common recommendation of CPAs for minimal salary to avoid paying employee/employer FICA. This recommendation is seriously out of date.

There have been two (that I know of) fairly recent (last few years) Tax Court rulings. The rulings I am aware of held that arbitrary low salaries (coincidentally, I believe they both were about $24K) are not justifiable. In both cases they ruled that 10% - 20% of revenues were not sufficient, and I believe (from memory) they assessed more like 50% - 60%. In both cases the IRS was able to retroactive establish proper salaries and assess FICA payments and penalties.

The IRS has established clear guidelines for establishing reasonable salaries. I don't have a cite, Google is your friend. There are a lot of pieces to this, with companies with capital investment, significant inventories, etc... still allowed to have salaries at a lower percentage of net profit. However, self-employment of personal services need to be mostly based on a % of net profit with input of comparable salaries for equivalent services. The CPAs I know recommend 50% - 75%. My CPA recommends the same allotment that technical employment agencies in my area use (65% contractor / 35% company).

Understatement of salary to avoid FICA taxes are on the IRS' hit list. Self employment already gets higher scrutiny for audits than wage earners. Forewarned is forearmed.

clayr361
Posts: 20
Joined: Tue Aug 19, 2014 2:48 pm

Re: Individual 401K Contribution Questions

Post by clayr361 » Wed Sep 17, 2014 3:40 pm

Spirit Rider wrote:Generally, for an Individual 401K the employer contribution is a non elective profit sharing contribution and not an elective match. From a purely tax point of view it does not matter whether pre-tax contributions are from employee deferrals or employer contributions. The only difference would be if some or all of the employee deferral is a Roth contribution. In that case the Roth contribution is not deductible.

However, I mostly want to comment on something else. From your description of paying yourself, I assume you are either a corporation (likely with an S-Corp election), or an LLC with an S-Corp election. The mention of $24K sends up a big red flag to me and probably the IRS. Please tell me that your business net profit is < $50K. A fixed salary allotment of $2K a month used to be a common recommendation of CPAs for minimal salary to avoid paying employee/employer FICA. This recommendation is seriously out of date.

There have been two (that I know of) fairly recent (last few years) Tax Court rulings. The rulings I am aware of held that arbitrary low salaries (coincidentally, I believe they both were about $24K) are not justifiable. In both cases they ruled that 10% - 20% of revenues were not sufficient, and I believe (from memory) they assessed more like 50% - 60%. In both cases the IRS was able to retroactive establish proper salaries and assess FICA payments and penalties.

The IRS has established clear guidelines for establishing reasonable salaries. I don't have a cite, Google is your friend. There are a lot of pieces to this, with companies with capital investment, significant inventories, etc... still allowed to have salaries at a lower percentage of net profit. However, self-employment of personal services need to be mostly based on a % of net profit with input of comparable salaries for equivalent services. The CPAs I know recommend 50% - 75%. My CPA recommends the same allotment that technical employment agencies in my area use (65% contractor / 35% company).

Understatement of salary to avoid FICA taxes are on the IRS' hit list. Self employment already gets higher scrutiny for audits than wage earners. Forewarned is forearmed.


Just had to take a look at my tax return and net profit last year was 51K so I am pretty close to the 50%. I am set up as an LLC with S-Corp election. When you say to avoid paying FICA are you saying to avoid paying them altogether or to avoid paying any more than on the 24K? I saw on my tax return where I paid both medicare and social security so I did not avoid paying them.

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

Re: Individual 401K Contribution Questions

Post by Spirit Rider » Wed Sep 17, 2014 5:34 pm

clayr361 wrote:Just had to take a look at my tax return and net profit last year was 51K so I am pretty close to the 50%. I am set up as an LLC with S-Corp election. When you say to avoid paying FICA are you saying to avoid paying them altogether or to avoid paying any more than on the 24K? I saw on my tax return where I paid both Medicare and social security so I did not avoid paying them.

You are fine with $24K salary on $51K of net profit.

It was just the $24K that sparked my concern. This used to be the standard salary recommendation for many CPAs. This was true whether you had $50K or $250K in net profit. Since both the employee and employer FICA is based the W2 wages of the S-Corp, the lower your salary, the lower your FICA tax cost.

Sorry for the false alarm.

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