Distribution or W2 from single owner S-Corp

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VAinvestor001
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Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Fri Jan 12, 2018 12:58 pm

Situation
  • Me and my wife both have W2 jobs and max 401k, as well as backdoor Roths (combined W2 salary from jobs ~210K, my W2 is >120K for SSN purposes)
  • Have a personal business that I am 100% owner, registered as S-Corp, generates about 100K of cash flow
    • I can pay myself a large amount W2 and pay all associated taxes ... in this scenario can contribute to SEP IRA about 25% of my W2 through business though haven't contributed yet
    • second option is take a small W2 and rest as distribution
Question
Any suggestion on what is more tax efficient? We are a family of 4 with 2 small kids ~4 and 6. I think I will end up in 24% tax bracket of married filing jointly

I am open to pay a tax consulting fee if someone can help with this in detail. My experience with CPA, Tax Consultants has not been great so far.. everyone says different thing and want to do just minimum

The business is in Virginia and I can't add any other member to the structure.

Thanks

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Duckie
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Re: Distribution or W2 from single owner S-Corp

Post by Duckie » Fri Jan 12, 2018 5:51 pm

VAinvestor001 wrote:Me and my wife both have W2 jobs and max 401k, as well as backdoor Roths
<snip>
in this scenario can contribute to SEP IRA about 25% of my W2 through business though haven't contributed yet
If you have a SEP IRA you will not be able to use the backdoor method. Your wife will. If you do not have any employees consider a solo 401k instead.

rutrow2015
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Re: Distribution or W2 from single owner S-Corp

Post by rutrow2015 » Fri Jan 12, 2018 5:54 pm

Regarding how much to take as W2 vs. distribution. That is not a question about tax efficiency but it is a question about what's legal and what will get you audited.

You need to talk with your CPA but a rough guideline is "what would you have to pay someone with your experience in order to retain them to do the job that you are doing for the S Corp"... THAT is the correct amount to take as a W2.

DSInvestor
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Re: Distribution or W2 from single owner S-Corp

Post by DSInvestor » Fri Jan 12, 2018 6:14 pm

In your situation where you've maxed out social security at your main job, S-Corp is going to cost you because your S-Corp W-2 salary is subject to social security and medicare withholding and is not aware of withholdings taken out by other employers. The employee social security withholding above the max can be recovered at tax time once your W-2's are aggregated at tax time. The employer social security withholdings paid by your S-Corp cannot be recovered. In this respect, sole proprietor filing schedules S and SE is advantageous. Schedule SE considers your other W-2s and if you've maxed out social security at your other job, you don't have to pay the social security portion of the self employment tax.

I would also recommend that you talk to a tax specialist to get advice on an appropriate level of W-2 compensation for your self employed business.
Wiki

Jamesla30
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Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Fri Jan 12, 2018 6:29 pm

DSInvestor wrote:
Fri Jan 12, 2018 6:14 pm
In your situation where you've maxed out social security at your main job, S-Corp is going to cost you because your S-Corp W-2 salary is subject to social security and medicare withholding and is not aware of withholdings taken out by other employers. The employee social security withholding above the max can be recovered at tax time once your W-2's are aggregated at tax time. The employer social security withholdings paid by your S-Corp cannot be recovered. In this respect, sole proprietor filing schedules S and SE is advantageous. Schedule SE considers your other W-2s and if you've maxed out social security at your other job, you don't have to pay the social security portion of the self employment tax.

I would also recommend that you talk to a tax specialist to get advice on an appropriate level of W-2 compensation for your self employed business.
I had never heard of this, but if true, this is probably the best advice. DSInvestor -- so if he maxes out social security limit at his other job, would he only be responsible for the 2.9% on his full $100k of business income? I would also add that the social security limit for 2018 will be $128,400 so he may not be quite maxed out.

Jamesla30
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Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Fri Jan 12, 2018 6:42 pm

I will also add that paying yourself a higher W2 just to take advantage of SEP-IRA or Solo 401k contribution is never worthwhile if you do the math. This is because you have to pay 15.3% taxes on the W2 wages, but your only getting back 25% of your tax rate in savings (25% of your salary can be contributed to retirement plan). So 24% bracket would save you 6%.

So you're paying 15.3% in taxes in order to save 6% in taxes for every dollar you pay yourself in W2 wages.

The others are right as well, you need to pay yourself a "reasonable salary", but keep it as low as possible.

If the previous poster is right and your other job's income counts towards the social security maximum, then I would absolutely dissolve the s-corp and run it through as a sole proprietorship.

Keep in mind too you if you and your wife can keep your total income below $385k (phases out at $485k), you will get a 20% deduction for your $100k of business income. So $20k deduction (x24% = $4800 tax savings).

Jamesla30
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Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Fri Jan 12, 2018 6:49 pm

Duckie wrote:
Fri Jan 12, 2018 5:51 pm
VAinvestor001 wrote:Me and my wife both have W2 jobs and max 401k, as well as backdoor Roths
<snip>
in this scenario can contribute to SEP IRA about 25% of my W2 through business though haven't contributed yet
If you have a SEP IRA you will not be able to use the backdoor method. Your wife will. If you do not have any employees consider a solo 401k instead.
This is not true. You can still have SEP IRA and do Backdoor Roth Contributions. However, if you have a balance in a traditional IRA or keep a balance in SEP IRA (also traditional for tax purposes), then you will have to pay taxes on a portion of your backdoor conversions, which sort of defeats the purpose. But there is a loophole for this scenario....

If you don't keep a balance in traditional IRA, you can always roll over your SEP to Roth and also never maintain a balance. I actually did this same scenario for several years and rolled over SEP IRA contributions into my ROTH (and paid the taxes on it). It basically acts like a second backdoor roth conversion account. See exact scenario here: https://www.nerdwallet.com/blog/investi ... on-limits/

I don't think there would be any advantage to a solo 401k over a SEP IRA because you are not making employee contributions. You are only doing 25% of your salary. I'm not even sure you could do the 25% employer contribution in a solo 401k if there is no employee contribution.

Another reason sole proprietorship would be a great choice (if the SS taxes don't apply) is that you could do 20% of the full $100k into retirement plan instead of 25% of W2 wages. I think at least. I have never done sole proprietor so i'm not positive but i believe that is how it works.

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Fri Jan 12, 2018 7:24 pm

So to summarize, it sounds to me like you would want to dissolve your s-corp and run the $100k business income as sole proprietorship. You could set it up as an LLC to try to limit some liability and separate the business. As long as you are the only owner it will automatically get taxed as if you were a sole proprietorship, you don't have to make an election. Then setup a SEP IRA and contribute 20% of business profit each year (again.. check that figure). I would recommend doing your backdoor roth contributions/conversions at the beginning of the year, and your SEP contribution/conversion at the end of the year. This will avoid mixing balances in those accounts at the time of conversion, which could cause tax problems.

DM me if I can help.

nolesrule
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Re: Distribution or W2 from single owner S-Corp

Post by nolesrule » Sat Jan 13, 2018 12:33 am

You're assuming the OP wants to put his business plan retirement money into Roth and not tax-deferred.

If he wants tax-deferred, he's better off with the Solo 401k for the reasons outlined by Duckie.

Seeing as we're talking about income levels above the SS cap and needing to do a backdoor Roth, tax-deferral is probably the better choice.

VAinvestor001
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Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 7:47 pm

Thanks for all the replies, really appreciate the wisdom of this board.

I will spend time absorbing all the answers and post again in a day or so.

Thanks again!

VAinvestor001
Posts: 26
Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:35 pm

rutrow2015 wrote:
Fri Jan 12, 2018 5:54 pm
Regarding how much to take as W2 vs. distribution. That is not a question about tax efficiency but it is a question about what's legal and what will get you audited...
Thanks for the note... I talked to a CPA and my contribution is way above his recommendation. I put less time in the business and can get away by paying myself around 25-30K and pass all audits.

VAinvestor001
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Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:38 pm

DSInvestor wrote:
Fri Jan 12, 2018 6:14 pm
In this respect, sole proprietor filing schedules S and SE is advantageous. Schedule SE considers your other W-2s and if you've maxed out social security at your other job, you don't have to pay the social security portion of the self employment tax.

I would also recommend that you talk to a tax specialist to get advice on an appropriate level of W-2 compensation for your self employed business.
Sole Proprietor puts all the risk on me... the business has many client interactions and i want protection of a legal entity (even an LLC will be fine). Initially we set up an LLC but CPA asked me to convert to SCORP for better tax treatment.

If you know a good tax specialist, please direct message me

VAinvestor001
Posts: 26
Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:40 pm

Jamesla30 wrote:
Fri Jan 12, 2018 6:29 pm
I had never heard of this, but if true, this is probably the best advice. DSInvestor -- so if he maxes out social security limit at his other job, would he only be responsible for the 2.9% on his full $100k of business income? I would also add that the social security limit for 2018 will be $128,400 so he may not be quite maxed out.
To add more here, my individual W2 is over 130K... and also business is looking to generate about 140K this year. I do not have any full time employees in business but several part timers.

VAinvestor001
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Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:43 pm

Thanks Jamesla

i am afraid of sole prop because of liability concerns. Can i put business in LLC and have tax treatment of a sole proprietorship? Sorry if this sounds weird but talking to CPAs have fried my brain here.

Thanks for the note on 385K, i will make sure to take as less as possible in W2 for 2018
Jamesla30 wrote:
Fri Jan 12, 2018 6:42 pm
I will also add that paying yourself a higher W2 just to take advantage of SEP-IRA or Solo 401k contribution is never worthwhile if you do the math. This is because you have to pay 15.3% taxes on the W2 wages, but your only getting back 25% of your tax rate in savings (25% of your salary can be contributed to retirement plan). So 24% bracket would save you 6%.

So you're paying 15.3% in taxes in order to save 6% in taxes for every dollar you pay yourself in W2 wages.

The others are right as well, you need to pay yourself a "reasonable salary", but keep it as low as possible.

If the previous poster is right and your other job's income counts towards the social security maximum, then I would absolutely dissolve the s-corp and run it through as a sole proprietorship.

Keep in mind too you if you and your wife can keep your total income below $385k (phases out at $485k), you will get a 20% deduction for your $100k of business income. So $20k deduction (x24% = $4800 tax savings).

VAinvestor001
Posts: 26
Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:47 pm

Thanks for the summary.. and get your point on LLC and sole proprietorship...
Jamesla30 wrote:
Fri Jan 12, 2018 7:24 pm
So to summarize, it sounds to me like you would want to dissolve your s-corp and run the $100k business income as sole proprietorship. You could set it up as an LLC to try to limit some liability and separate the business. As long as you are the only owner it will automatically get taxed as if you were a sole proprietorship, you don't have to make an election. Then setup a SEP IRA and contribute 20% of business profit each year (again.. check that figure). I would recommend doing your backdoor roth contributions/conversions at the beginning of the year, and your SEP contribution/conversion at the end of the year. This will avoid mixing balances in those accounts at the time of conversion, which could cause tax problems.

DM me if I can help.

VAinvestor001
Posts: 26
Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 8:48 pm

Yes tax deferral is best option as I don't anticipate higher earnings more than 5-6 years into future...
nolesrule wrote:
Sat Jan 13, 2018 12:33 am
You're assuming the OP wants to put his business plan retirement money into Roth and not tax-deferred.

If he wants tax-deferred, he's better off with the Solo 401k for the reasons outlined by Duckie.

Seeing as we're talking about income levels above the SS cap and needing to do a backdoor Roth, tax-deferral is probably the better choice.

nolesrule
Posts: 624
Joined: Thu Feb 26, 2015 10:59 am

Re: Distribution or W2 from single owner S-Corp

Post by nolesrule » Sat Jan 13, 2018 10:34 pm

There are issues setting up a solo 401k if you have employees. Are these part-time employees W-2? Do they work less than 1000 hours/year?

VAinvestor001
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Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Sat Jan 13, 2018 10:37 pm

yes all part time working less than 1000 hrs on W2
nolesrule wrote:
Sat Jan 13, 2018 10:34 pm
There are issues setting up a solo 401k if you have employees. Are these part-time employees W-2? Do they work less than 1000 hours/year?

nolesrule
Posts: 624
Joined: Thu Feb 26, 2015 10:59 am

Re: Distribution or W2 from single owner S-Corp

Post by nolesrule » Sat Jan 13, 2018 11:28 pm

VAinvestor001 wrote:
Sat Jan 13, 2018 10:37 pm
yes all part time working less than 1000 hrs on W2
nolesrule wrote:
Sat Jan 13, 2018 10:34 pm
There are issues setting up a solo 401k if you have employees. Are these part-time employees W-2? Do they work less than 1000 hours/year?
When you set up the Solo 401k, make sure you include eligibility requirements that exclude the part-time employees. I remember that being part of the forms I filled out for my Fidelity solo 401k. Otherwise, they'll all be eligible to participate and you won't have a solo 401k.

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Sat Jan 13, 2018 11:30 pm

VAinvestor001 wrote:
Sat Jan 13, 2018 8:43 pm
Thanks Jamesla
i am afraid of sole prop because of liability concerns. Can i put business in LLC and have tax treatment of a sole proprietorship? Sorry if this sounds weird but talking to CPAs have fried my brain here.

Thanks for the note on 385K, i will make sure to take as less as possible in W2 for 2018
Yes. If you set up the business as an LLC, it will default to sole proprietorship for tax treatment. You can also "elect" to have it treated as an s-corp for tax purposes. The election is a very simple federal form that is filed.

In regards to the $385k for tax deduction under the new lax.... this includes all your business income as well, so changing your W2 amount does not matter. $20k salary + $80k profit = $60k salary + $40k profit. Both show as $100k income on your tax return. If you would happen to go over the $485k phase out in the future, you can still get a deduction equal to 50% of W2 wages paid to yourself and your employees.

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Sat Jan 13, 2018 11:32 pm

VAinvestor001 wrote:
Sat Jan 13, 2018 8:48 pm
Yes tax deferral is best option as I don't anticipate higher earnings more than 5-6 years into future...
nolesrule wrote:
Sat Jan 13, 2018 12:33 am
You're assuming the OP wants to put his business plan retirement money into Roth and not tax-deferred.

If he wants tax-deferred, he's better off with the Solo 401k for the reasons outlined by Duckie.

Seeing as we're talking about income levels above the SS cap and needing to do a backdoor Roth, tax-deferral is probably the better choice.
The previous poster is correct then, do solo 401k instead of SEP as 401k balances do not effect backdoor roth rules.

VAinvestor001
Posts: 26
Joined: Wed May 13, 2015 9:07 am

Re: Distribution or W2 from single owner S-Corp

Post by VAinvestor001 » Mon Jan 15, 2018 11:00 am

Thanks for all the info. Deadline to set up solo 401K is Dec 31 so that ship has sailed for 2017.. i can still do Sep IRA...

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: Distribution or W2 from single owner S-Corp

Post by Jamesla30 » Mon Jan 15, 2018 11:43 am

VAinvestor001 wrote:
Mon Jan 15, 2018 11:00 am
Thanks for all the info. Deadline to set up solo 401K is Dec 31 so that ship has sailed for 2017.. i can still do Sep IRA...
If you do SEP just make sure you transfer to ROTH immediately after your contribution and make sure you don't have a balance in a Traditional IRA. Keep in mind you will get the business deduction for the contribution, but the conversion will appear as income on your taxes. Basically they will cancel each other out. Essentially it is like you are contributing directly to your ROTH with after tax funds.

For 2018 you could set up the 401k.

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