Should Pass-Thru's Now Increase Salaries vs. Distributions?

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

Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Fri Jan 12, 2018 2:00 pm

I have a small single owner/single employee LLC business set up as a pass thru (s-corp) for tax purposes. In past years, the goal was to minimize your salary vs. distributions to avoid paying payroll taxes (15.3%). However, with the new tax legislation, high income businesses such as myself are re-thinking this. My business will be above the 20% business deduction as our MFJ income will be above the $415k phase out. However, that business WILL qualify for a deduction of 50% of W2 wages paid. Meaning I can deduct 50% of my own salary.

My question is, wouldn't it now be in my best interest to pay myself a salary of $140k instead of $60k? Let's assume I have a 28% effective tax rate. It will probably be higher, but that would only increase the benefit, so i'll be conservative.

Here is my math:

The $80k increase of salary will incur the following taxes:
7.65% employer tax (but that is a business expense, so I will deduct 28% from that rate), 5.5% = $4,400
7.65% employee tax = $6120
TOTAL = $10,520

However, because of the new tax law I will get an additional business deduction of $40k (50% of additional wages)
$40k x 28% tax savings = $11,200

Thats a savings of about $700.

Also keep in mind that some of these new wages will be above the max social security income limit, so $12k or will be excluded from those 12.4% taxes. The savings will actually be about $1900 if you factor that in.

I can also now contribute another $20,000 (25% of salary) to my 401k = $5600 tax savings. I would be contributing the $53k max now.

Additionally, I will be adding to my lifetime social security wages, so would get some benefit down the road once I collect social security.

So overall, about $7500 in tax savings, plus higher SS payments down the road.

What am I missing?

Do you think there will be trend of single owner/employee pass thru's doing exactly this?

Jamesla30
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Sat Jan 13, 2018 11:18 pm

bump :)

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MP123
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by MP123 » Sun Jan 14, 2018 12:28 am

As long as you aren't a specified service business I think your numbers above are right but there isn't much clear guidance on Sec. 199a yet.

Your proposed additional wages are quite a bit above the second bend point for SS though so you won't realize much advantage when it comes to collecting SS because you'll only get a small percentage of them back.

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Epsilon Delta
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Epsilon Delta » Sun Jan 14, 2018 12:38 pm

MP123 wrote:
Sun Jan 14, 2018 12:28 am
Your proposed additional wages are quite a bit above the second bend point for SS though so you won't realize much advantage when it comes to collecting SS because you'll only get a small percentage of them back.
That depends on how long he works at the high wages. A few years of high wages earns the same SS benefit as a lot of years of low wages. For somebody who had a misspent youth or plans to misspend middle age a few years of high earnings can still be below the bend points,

Jamesla30
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Mon Jan 15, 2018 11:46 am

Thanks for the replies. The increased SS benefits would really just be a bonus, as I would already be ahead in regards to taxes paid. The biggest benefit seems to be that it would allow another $20k in retirement contributions/deduction.

pshonore
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by pshonore » Mon Jan 15, 2018 1:36 pm

Jamesla30 wrote:
Fri Jan 12, 2018 2:00 pm
I have a small single owner/single employee LLC business set up as a pass thru (s-corp) for tax purposes. In past years, the goal was to minimize your salary vs. distributions to avoid paying payroll taxes (15.3%). However, with the new tax legislation, high income businesses such as myself are re-thinking this. My business will be above the 20% business deduction as our MFJ income will be above the $415k phase out. However, that business WILL qualify for a deduction of 50% of W2 wages paid. Meaning I can deduct 50% of my own salary.

My question is, wouldn't it now be in my best interest to pay myself a salary of $140k instead of $60k? Let's assume I have a 28% effective tax rate. It will probably be higher, but that would only increase the benefit, so i'll be conservative.

Here is my math:

The $80k increase of salary will incur the following taxes:
7.65% employer tax (but that is a business expense, so I will deduct 28% from that rate), 5.5% = $4,400
7.65% employee tax = $6120
TOTAL = $10,520

However, because of the new tax law I will get an additional business deduction of $40k (50% of additional wages)
$40k x 28% tax savings = $11,200

Thats a savings of about $700.

Also keep in mind that some of these new wages will be above the max social security income limit, so $12k or will be excluded from those 12.4% taxes. The savings will actually be about $1900 if you factor that in.

I can also now contribute another $20,000 (25% of salary) to my 401k = $5600 tax savings. I would be contributing the $53k max now.

Additionally, I will be adding to my lifetime social security wages, so would get some benefit down the road once I collect social security.

So overall, about $7500 in tax savings, plus higher SS payments down the road.

What am I missing?

Do you think there will be trend of single owner/employee pass thru's doing exactly this?
Are you certain the 50% deduction includes "owner" W2 wages. Seems counter intuitive that the QBI deduction is 20% of business income for lower income small business without even considering owner wages (and there's even disagreement about that) and higher incomes get to take 50% of their wages?? I think there's still a lot to be thrashed out and if we're lucky it might all be resolved by this time next year.

Jamesla30
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Mon Jan 15, 2018 7:17 pm

pshonore wrote:
Mon Jan 15, 2018 1:36 pm
Are you certain the 50% deduction includes "owner" W2 wages. Seems counter intuitive that the QBI deduction is 20% of business income for lower income small business without even considering owner wages (and there's even disagreement about that) and higher incomes get to take 50% of their wages?? I think there's still a lot to be thrashed out and if we're lucky it might all be resolved by this time next year.
Yes I have read the rules in detail and have discussed with my accountant and this is how the rules work. Technically I am an owner and employee of the business. If I had more employees I would be able to deduct 50% of their wages as well.

But you are correct, it is a bit counter intuitive. See example below between two single owner/employee businesses.

Business profits $300k, owner pays himself $50k. Owner gets $60k deduction.
Business profits $600k, owner pays himself $50k. Owner gets $25k deduction.

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

Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Tue Jan 16, 2018 1:25 pm

Well I just went ahead and adjusted my salary from $60k in 2017 to $146k in 2018. Seems odd but financially it makes sense. According to my calculations, I will pay $2600 less in taxes, plus another $6020 in tax savings from the additional $21,500 that I will contribute towards my 401k (maxing at $55k).

$8,620 total tax savings. Plus a little more SS benefits down the road (hopefully at least).

I would suggest other high earning single owner s-corps with low salary do the same. I don't see how it doesn't make sense for anyone that fits this criteria.

oktax
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Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by oktax » Tue Jan 16, 2018 1:43 pm

Your analysis looks correct to me. Something worth noting: if your LLC weren't taxed as an S corp., your increase in salary wouldn't reap you a benefit under a strict reading of 199A.

By default, the single owner LLC is taxed as a disregarded entity, or sole proprietorship. If your business were a sole prop., you couldn't pay yourself W-2 wages. Because your taxable income exceeds the thresholds and phase-in of the W-2/basis limit, your deduction would be zero under your facts if the LLC were taxed as a disregarded entity. The same holds true for if your LLC were multi-member and taxed as a partnership--partners can't pay themselves W-2 wages, so the deduction would be zero under your facts if the LLC were a tax partnership as well.

199A is a very strange provision.

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

Re: Should Pass-Thru's Now Increase Salaries vs. Distributions?

Post by Jamesla30 » Tue Jan 16, 2018 3:25 pm

oktax wrote:
Tue Jan 16, 2018 1:43 pm
Your analysis looks correct to me. Something worth noting: if your LLC weren't taxed as an S corp., your increase in salary wouldn't reap you a benefit under a strict reading of 199A.

By default, the single owner LLC is taxed as a disregarded entity, or sole proprietorship. If your business were a sole prop., you couldn't pay yourself W-2 wages. Because your taxable income exceeds the thresholds and phase-in of the W-2/basis limit, your deduction would be zero under your facts if the LLC were taxed as a disregarded entity. The same holds true for if your LLC were multi-member and taxed as a partnership--partners can't pay themselves W-2 wages, so the deduction would be zero under your facts if the LLC were a tax partnership as well.

199A is a very strange provision.
Yes I agree. Seems to un-proportionally benefit business owners with total incomes less than $385k. And any owners with incomes above that need to make sure they are set up as s-corp with high W2 salaries to get benefits.

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