Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

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CoastLawyer2030
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Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

I moonlight with a solo law practice. It is an LLC taxed as an S-Corp. I pay myself a $30,000/year salary, as profits (after salary) have been in the $60k ballpark for three years running.

The issue now is that I currently have $44,000 cash on hand at the end of the year and am wondering whether I should stuff a bunch of money into my 401k. I expect profit (i.e., after my salary) to be around $80,000 at EOY, as I've had an unexpectedly great year due to a nice settlement.

I understand how 401k reduces AGI, but I have two more nuanced concerns --

1. I have done zero 401k contributions yet, so to do the 401k max as an employee, I'm concerned that raising salary just makes the entire thing a wash because it increases my payroll tax. In other words, since I've already paid myself $23k of the $30k salary, to contribute $19.5k over the next two months, I'd have to raise salary to approximately $45,000. That increases my payroll tax quite a bit. I'm not sure if that's worth it.

2. How do 401k contributions affect QBI deductions? Is it more or less advantageous to contribute as an employee or employer?

All help appreciated.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

What are you doing in terms of a retirement plan with your day job?
mikejuss
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by mikejuss »

I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
Luckywon
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by Luckywon »

Look into making megabackdoor Roth contributions. You should be able to make $30k in contributions without increasing your salary and my understanding is these do not reduce QBI.

Your 401k plan must allow these, not all do. If yours does not, you could consider moving your plan to a company like Employee Fiduciary. Many threads on this in this forum.

Perhaps a reasonable approach if you don't want to increase your salary is a hybrid one where you contribute what you still can in pre-tax employee contributions, and the remainder in mega backdoor roth.
mikejuss
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by mikejuss »

nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
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cowdogman
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by cowdogman »

CoastLawyer2030 wrote: Wed Oct 13, 2021 2:26 pm I moonlight with a solo law practice. It is an LLC taxed as an S-Corp. I pay myself a $30,000/year salary, as profits (after salary) have been in the $60k ballpark for three years running.

The issue now is that I currently have $44,000 cash on hand at the end of the year and am wondering whether I should stuff a bunch of money into my 401k. I expect profit (i.e., after my salary) to be around $80,000 at EOY, as I've had an unexpectedly great year due to a nice settlement.

I understand how 401k reduces AGI, but I have two more nuanced concerns --

1. I have done zero 401k contributions yet, so to do the 401k max as an employee, I'm concerned that raising salary just makes the entire thing a wash because it increases my payroll tax. In other words, since I've already paid myself $23k of the $30k salary, to contribute $19.5k over the next two months, I'd have to raise salary to approximately $45,000. That increases my payroll tax quite a bit. I'm not sure if that's worth it.

2. How do 401k contributions affect QBI deductions? Is it more or less advantageous to contribute as an employee or employer?

All help appreciated.
Similar position (attorney, LLC) but am taxed as a sole proprietor (Schedule C). My understanding is that given that my only revenues are from my hourly rate, then the bulk of my profit needs to be treated as salary to be "reasonable" for the IRS ("what others are paid for similar work"). The hassle of having to pay myself as an employee (payroll, employment law compliance, etc.) didn't seem to be worth the effort for the small amount I could take as a non-salary distribution.

For me, (1) a solo 401(k) pre-tax contribution, (2) any self employed health insurance deduction contribution and (3) the self-employment tax deduction will reduce the QBI deduction. But a solo 401(k) pre-tax contribution will increase any ACA subsidy/credit because it lowers AGI. Not sure how it would work as an S corp.

As to whether it is more advantageous to make an employer or employee contribution, I don't think it matters, tho employee deferrals can be allocated to a solo 401(k) trad and/or Roth account. Employer contributions can go only to a trad account.
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cowdogman
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by cowdogman »

mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
It's roughly 20%. Fill out this form to determine your max employer contribution:

https://www.fidelity.com/bin-public/060 ... siness.pdf

P.S., Link now fixed.
mikejuss
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by mikejuss »

cowdogman wrote: Wed Oct 13, 2021 2:58 pm
mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
It's roughly 20%. Fill out this form to determine your max employer contribution:

https://www.fidelity.com/bin-public/060 ... siness.pdf

P.S., Link now fixed.
Thanks! :beer
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
For an S-Corp, you have to actually have payroll for yourself for the compensation that counts toward solo 401k calculations. It doesn't matter how much revenue the business makes. It's dependent on your paycheck. And you don't have to make the employer contribution with each paycheck. You have until the corporation filing deadline to make the employer contribution.

It's the calculations for Schedule C filers where it gets complicated.
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cowdogman
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by cowdogman »

nolesrule wrote: Wed Oct 13, 2021 3:08 pm
mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
For an S-Corp, you have to actually have payroll for yourself for the compensation that counts toward solo 401k calculations. It doesn't matter how much revenue the business makes. It's dependent on your paycheck. And you don't have to make the employer contribution with each paycheck. You have until the corporation filing deadline to make the employer contribution.

It's the calculations for Schedule C filers where it gets complicated.
Yes, we could probably have debate about which is more complicated, but my input is limited to what I know--Schedule C. Thanks.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

mikejuss wrote: Wed Oct 13, 2021 3:05 pm
cowdogman wrote: Wed Oct 13, 2021 2:58 pm
mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
It's roughly 20%. Fill out this form to determine your max employer contribution:

https://www.fidelity.com/bin-public/060 ... siness.pdf

P.S., Link now fixed.
Thanks! :beer
That doesn't apply to an S-Corp. That's for Sole proprietors and partnership K-1s.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

cowdogman wrote: Wed Oct 13, 2021 3:11 pm
nolesrule wrote: Wed Oct 13, 2021 3:08 pm
mikejuss wrote: Wed Oct 13, 2021 2:55 pm
nolesrule wrote: Wed Oct 13, 2021 2:41 pm
mikejuss wrote: Wed Oct 13, 2021 2:33 pm I'd also love a clear-cut explanation of how to calculate how much a person with an individual 401(k) can contribute to it as an employer.
For an S-Corp it's pretty simple. The employer contribution can be up to 25% of the owner-employee's salary compensation up to the maximum eligible compensation. Also it's still subject to the per-employer total contribution limit.
My understanding--and perhaps it's off base--is that the 25% figure you mention has a lot of asterisks attached to it, not the least of which is that someone who is self-employed may not know what his compensation for the year will be until that year is over.
For an S-Corp, you have to actually have payroll for yourself for the compensation that counts toward solo 401k calculations. It doesn't matter how much revenue the business makes. It's dependent on your paycheck. And you don't have to make the employer contribution with each paycheck. You have until the corporation filing deadline to make the employer contribution.

It's the calculations for Schedule C filers where it gets complicated.
Yes, we could probably have debate about which is more complicated, but my input is limited to what I know--Schedule C. Thanks.

I've done both S-Corp and Schedule C with Solo 401k. The S-Corp is much less complicated when it comes to Solo 401k calculations, but is more work with reporting and filing of taxes (1120S, K-1, federal and state payroll taxes).
fyre4ce
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

CoastLawyer2030 wrote: Wed Oct 13, 2021 2:26 pm I moonlight with a solo law practice. It is an LLC taxed as an S-Corp. I pay myself a $30,000/year salary, as profits (after salary) have been in the $60k ballpark for three years running.

The issue now is that I currently have $44,000 cash on hand at the end of the year and am wondering whether I should stuff a bunch of money into my 401k. I expect profit (i.e., after my salary) to be around $80,000 at EOY, as I've had an unexpectedly great year due to a nice settlement.

I understand how 401k reduces AGI, but I have two more nuanced concerns --

1. I have done zero 401k contributions yet, so to do the 401k max as an employee, I'm concerned that raising salary just makes the entire thing a wash because it increases my payroll tax. In other words, since I've already paid myself $23k of the $30k salary, to contribute $19.5k over the next two months, I'd have to raise salary to approximately $45,000. That increases my payroll tax quite a bit. I'm not sure if that's worth it.

2. How do 401k contributions affect QBI deductions? Is it more or less advantageous to contribute as an employee or employer?

All help appreciated.
A few comments:
  • You need to make sure you're paying yourself a "reasonable" salary, defined as what you would pay someone else to do the same job. $30k wages on ~$110k profit after business expenses seems really low to me. After the section 199A deduction came into being, the IRS basically said that all business profits where the business revenue comes from your own labor (and this would seem to apply to your situation) should be paid as wages, and not as business profit. I would think your ratio of [W-2] / [W-2 + K-1] should be AT LEAST 50-60%, if not more.
  • There are two ways you can contribute to a 401k: as an employee, and as an employer. The employee part is up to $19,500 for 2021, and it can be pre-tax, or Roth if your Solo 401k allows it. You only get one employee contribution regardless of how many jobs you have, so if you have another W-2 job and use up the entire $19,500 there, then you get no employee contribution into your Solo 401k.
  • Your employer contributions can be up to 25% of your wages, and the total employer + employee contributions can't be more than the Section 415 limit of $58,000. They must be traditional/pre-tax.
  • If you have a mega-backdoor Roth capable Solo 401k, you can contribute a third category of employee after-tax contributions, which don't count against your $19,500 limit and can be immediately rolled over into a Roth account. Theoretically you can contribute the entire $58k limit into Roth this way, if your salary is >=$58k. In your income range, this might be worth considering, if your desire for Roth contributions exceeds the hassle and cost of having a third party administrator on your Solo 401k. You can read more about that here or by searching these forums.
  • Employer pre-tax contributions reduce your QBI deduction, so you contribute at an effectively lower tax rate. Say you were in California in the 24% federal and 9.3% state brackets. Your tax savings on an employer pre-tax contribution would be 24% * 80% + 9.3% = 28.5%, less than your 33.3% marginal rate. For this reason, if you're eligible for the QBI deduction it's better to contribute from the employee contribution first. I posted a tool here that will estimate your future tax rates, and tell you whether pre-tax contributions at this reduced rate are worth making.
  • I posted an answer to a very similar question in another thread today. I included a spreadsheet that helps make the trade-off between QBI, payroll taxes, and retirement contributions. Check out that thread, download the spreadsheet, and play around with it to see if it helps.
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CoastLawyer2030
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

nolesrule wrote: Wed Oct 13, 2021 2:29 pm What are you doing in terms of a retirement plan with your day job?
I have a 457 with my City employer, which I max up to the $19,500 limit.

My understanding is that I can contribute to both the 457 and the 401k.
Topic Author
CoastLawyer2030
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

cowdogman wrote: Wed Oct 13, 2021 2:56 pm
CoastLawyer2030 wrote: Wed Oct 13, 2021 2:26 pm I moonlight with a solo law practice. It is an LLC taxed as an S-Corp. I pay myself a $30,000/year salary, as profits (after salary) have been in the $60k ballpark for three years running.

The issue now is that I currently have $44,000 cash on hand at the end of the year and am wondering whether I should stuff a bunch of money into my 401k. I expect profit (i.e., after my salary) to be around $80,000 at EOY, as I've had an unexpectedly great year due to a nice settlement.

I understand how 401k reduces AGI, but I have two more nuanced concerns --

1. I have done zero 401k contributions yet, so to do the 401k max as an employee, I'm concerned that raising salary just makes the entire thing a wash because it increases my payroll tax. In other words, since I've already paid myself $23k of the $30k salary, to contribute $19.5k over the next two months, I'd have to raise salary to approximately $45,000. That increases my payroll tax quite a bit. I'm not sure if that's worth it.

2. How do 401k contributions affect QBI deductions? Is it more or less advantageous to contribute as an employee or employer?

All help appreciated.
Similar position (attorney, LLC) but am taxed as a sole proprietor (Schedule C). My understanding is that given that my only revenues are from my hourly rate, then the bulk of my profit needs to be treated as salary to be "reasonable" for the IRS ("what others are paid for similar work"). The hassle of having to pay myself as an employee (payroll, employment law compliance, etc.) didn't seem to be worth the effort for the small amount I could take as a non-salary distribution.

For me, (1) a solo 401(k) pre-tax contribution, (2) any self employed health insurance deduction contribution and (3) the self-employment tax deduction will reduce the QBI deduction. But a solo 401(k) pre-tax contribution will increase any ACA subsidy/credit because it lowers AGI. Not sure how it would work as an S corp.

As to whether it is more advantageous to make an employer or employee contribution, I don't think it matters, tho employee deferrals can be allocated to a solo 401(k) trad and/or Roth account. Employer contributions can go only to a trad account.
Not sure what your revenues are, but modern payroll software (I use Square) is incredibly easy. Costs $36/month. I save thousands on taxes per year. The mild headache is well worth it.
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CoastLawyer2030
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Wed Oct 13, 2021 3:56 pmA few comments:
  • You need to make sure you're paying yourself a "reasonable" salary, defined as what you would pay someone else to do the same job. $30k wages on ~$110k profit after business expenses seems really low to me. After the section 199A deduction came into being, the IRS basically said that all business profits where the business revenue comes from your own labor (and this would seem to apply to your situation) should be paid as wages, and not as business profit. I would think your ratio of [W-2] / [W-2 + K-1] should be AT LEAST 50-60%, if not more.
My City government pays lawyers $34,000/year for part time. I have basically elected to pay myself the exact same salary since it is a similar amount of hours as PT at my City job. Things got spiked this year because I received a $22k fee on a settlement. But I want to keep my salary roughly the same.
fyre4ce wrote: Wed Oct 13, 2021 3:56 pm [*]There are two ways you can contribute to a 401k: as an employee, and as an employer. The employee part is up to $19,500 for 2021, and it can be pre-tax, or Roth if your Solo 401k allows it. You only get one employee contribution regardless of how many jobs you have, so if you have another W-2 job and use up the entire $19,500 there, then you get no employee contribution into your Solo 401k.
As I posted up thread, my City job is a 457. My understanding is that I can contribute to both a 401k and a 457.
fyre4ce wrote: Wed Oct 13, 2021 3:56 pm [*]Employer pre-tax contributions reduce your QBI deduction, so you contribute at an effectively lower tax rate. Say you were in California in the 24% federal and 9.3% state brackets. Your tax savings on an employer pre-tax contribution would be 24% * 80% + 9.3% = 28.5%, less than your 33.3% marginal rate. For this reason, if you're eligible for the QBI deduction it's better to contribute from the employee contribution first. I posted a tool here that will estimate your future tax rates, and tell you whether pre-tax contributions at this reduced rate are worth making.
[*]I posted an answer to a very similar question in another thread today. I included a spreadsheet that helps make the trade-off between QBI, payroll taxes, and retirement contributions. Check out that thread, download the spreadsheet, and play around with it to see if it helps.[/list]
Thanks for this. This is helpful.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

CoastLawyer2030 wrote: Thu Oct 14, 2021 7:20 am
nolesrule wrote: Wed Oct 13, 2021 2:29 pm What are you doing in terms of a retirement plan with your day job?
I have a 457 with my City employer, which I max up to the $19,500 limit.

My understanding is that I can contribute to both the 457 and the 401k.
Yes, that is correct. 457s have a separate employee contribution.

As an S-Corp owner-employee, the employEE contribution has to be withheld as a paycheck deduction from your salary. EmployER contributions are a business expense and cannot exceed 25% of your salaried compensation. The total of the employEE and employER contributions cannot exceed the $58k limit. Note that the limits may change annually, so you would want to keep up with them.

fyre4ce did a great job of explaining the other considerations.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

nolesrule wrote: Thu Oct 14, 2021 7:50 am
CoastLawyer2030 wrote: Thu Oct 14, 2021 7:20 am
nolesrule wrote: Wed Oct 13, 2021 2:29 pm What are you doing in terms of a retirement plan with your day job?
I have a 457 with my City employer, which I max up to the $19,500 limit.

My understanding is that I can contribute to both the 457 and the 401k.
Yes, that is correct. 457s have a separate employee contribution.

As an S-Corp owner-employee, the employEE contribution has to be withheld as a paycheck deduction from your salary. EmployER contributions are a business expense and cannot exceed 25% of your salaried compensation. The total of the employEE and employER contributions cannot exceed the $58k limit. Note that the limits may change annually, so you would want to keep up with them.

fyre4ce did a great job of explaining the other considerations.
nolesrule is right that employee contributions have to be withheld from your paychecks. If you've already paid yourself a certain amount of wages, it will be difficult or impossible to go back and withhold employee contributions from that pay. You'd have to talk to your payroll provider about that.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Thu Oct 14, 2021 12:51 pm
CoastLawyer2030 wrote: Thu Oct 14, 2021 12:40 pm
fyre4ce wrote: Thu Oct 14, 2021 12:22 pm
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
Yes, but I was subcontracting my salary payroll tax (15.3%) to my distribution payroll tax (7.65%), or am I screwing that up?
Sorry, I don't understand what "subcontracting [your] salary payroll tax" means. It might just be a terminology thing, or maybe an actual misunderstanding. May I suggest you read the wiki article on payroll tax? The employee half comes out of your paycheck automatically. The employer half also gets paid to the IRS, but is a deductible business expense, so reduces taxable business profit (and after 2017, the QBI deduction for those eligible). But you end up paying both halves if you own the business.
Edited below...
Last edited by CoastLawyer2030 on Thu Oct 14, 2021 1:02 pm, edited 3 times in total.
nolesrule
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

If you really want to get into the weeds, you'd need to figure out how much the change in payroll taxes will contribute to a change in your Social Security benefits.

You also need to think about which tax bracket you will be in in retirement and if you will benefit from the tax deferral. Roth contributions are also an option if your solo 401k supports it.

Personally I think the contribution and increase to SS benefits in the long run outweigh the one-time reduction in QBI, but I don't have the numbers to back it up. I'd also be making employer contributions and not just employee contributions ($7500 on a $30k salary or $11250 on $45k salary), unless i needed the money for expenses.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by MP123 »

Employer contributions are usually preferred because they escape FICA. But you'd need to get your compensation higher to allow a larger contribution. That could be done with a one time bonus that all gets deferred to the solo K. You'd need to do the math to figure out the right ER/EE ratio while maximizing ER.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

CoastLawyer2030 wrote: Thu Oct 14, 2021 10:59 am
nolesrule wrote: Thu Oct 14, 2021 7:50 amYes, that is correct. 457s have a separate employee contribution.

As an S-Corp owner-employee, the employEE contribution has to be withheld as a paycheck deduction from your salary. EmployER contributions are a business expense and cannot exceed 25% of your salaried compensation. The total of the employEE and employER contributions cannot exceed the $58k limit. Note that the limits may change annually, so you would want to keep up with them.

fyre4ce did a great job of explaining the other considerations.
fyre4ce wrote: Thu Oct 14, 2021 10:35 amnolesrule is right that employee contributions have to be withheld from your paychecks. If you've already paid yourself a certain amount of wages, it will be difficult or impossible to go back and withhold employee contributions from that pay. You'd have to talk to your payroll provider about that.
So I guess that is my question -- since I have not contributed anything, I guess I have to increase payroll over the last two months to maximize the $19,500 employee contribution.

In other words, planned salary was $30,000. But since I already have run $23,000 in payroll, if I wanted to do the $19,500 maximum, then I'd probably have to run my payroll up to $45,000 (and pay myself $11,000 per month in November and December).

That, in turn, would increase my payroll tax, and also affect my QBI deduction, which is why I'm hesitant to do it.

My extremely amateur guess at the math is this:

Increase in payroll tax from $30k salary to $45k salary = 7.65% x $15,000 = $1,147

Current $80,000 Profit subject to QBI Deduction = $16,000 Deduction x .22 bracket = $3,520 taxes saved

But if I run payroll up to $45,000 = $65,000 Profit Subject to QBI Deduction = $13,000 deduction x .22 bracket $2,860

$3,520 - $2,860 = $660

$1,147 (Increased Payroll Tax) + $660 (Difference in QBI) = $1,807

Doing the 401k max as employee = $19,500 x .22 bracket = $4,290

Am I thinking about this right?
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
fyre4ce
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

nolesrule wrote: Thu Oct 14, 2021 11:21 am If you really want to get into the weeds, you'd need to figure out how much the change in payroll taxes will contribute to a change in your Social Security benefits.

You also need to think about which tax bracket you will be in in retirement and if you will benefit from the tax deferral. Roth contributions are also an option if your solo 401k supports it.

Personally I think the contribution and increase to SS benefits in the long run outweigh the one-time reduction in QBI, but I don't have the numbers to back it up. I'd also be making employer contributions and not just employee contributions ($7500 on a $30k salary or $11250 on $45k salary), unless i needed the money for expenses.
This is absolutely true. But it's important to realize that SS benefits are highly progressive. The three PIA brackets are 90%, 32%, and 15%. Especially for those in the 90% bracket, the return on paying SS taxes can be excellent, even if you have to pay both halves. Those in the 15% bracket can probably assume SS taxes are a total loss as a first approximation. 32% bracket is somewhere in between.

https://www.kitces.com/blog/social-secu ... t-roi-irr/

Also, there may be state benefits as well. My wife and I got ~$9,000 each of paid family leave when our son was born. If we had lower wages and lower state disability payroll taxes the amount would have been proportionally less.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Thu Oct 14, 2021 12:22 pm
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
Yes, but I was subtracting my salary payroll tax (15.3%) to my distribution payroll tax (7.65%), or am I screwing that up?
Last edited by CoastLawyer2030 on Thu Oct 14, 2021 12:53 pm, edited 1 time in total.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

CoastLawyer2030 wrote: Thu Oct 14, 2021 12:40 pm
fyre4ce wrote: Thu Oct 14, 2021 12:22 pm
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
Yes, but I was subcontracting my salary payroll tax (15.3%) to my distribution payroll tax (7.65%), or am I screwing that up?
Sorry, I don't understand what "subcontracting [your] salary payroll tax" means. It might just be a terminology thing, or maybe an actual misunderstanding. May I suggest you read the wiki article on payroll tax? The employee half comes out of your paycheck automatically. The employer half also gets paid to the IRS, but is a deductible business expense, so reduces taxable business profit (and after 2017, the QBI deduction for those eligible). But you end up paying both halves if you own the business.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Thu Oct 14, 2021 12:51 pm
CoastLawyer2030 wrote: Thu Oct 14, 2021 12:40 pm
fyre4ce wrote: Thu Oct 14, 2021 12:22 pm
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
Yes, but I was subcontracting my salary payroll tax (15.3%) to my distribution payroll tax (7.65%), or am I screwing that up?
Sorry, I don't understand what "subcontracting [your] salary payroll tax" means. It might just be a terminology thing, or maybe an actual misunderstanding. May I suggest you read the wiki article on payroll tax? The employee half comes out of your paycheck automatically. The employer half also gets paid to the IRS, but is a deductible business expense, so reduces taxable business profit (and after 2017, the QBI deduction for those eligible). But you end up paying both halves if you own the business.
I meant subtracting.

What I am saying is that if I increase my salary to $45,000, I have to pay 15.3% payroll tax on that increase from my previous salary (from $30,000). But beyond that $30,000 anyway, I have to pay 7.65% payroll tax anyway, right? Or I don't pay any payroll tax on distributions?
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Thu Oct 14, 2021 12:51 pmSorry, I don't understand what "subcontracting [your] salary payroll tax" means. It might just be a terminology thing, or maybe an actual misunderstanding. May I suggest you read the wiki article on payroll tax? The employee half comes out of your paycheck automatically. The employer half also gets paid to the IRS, but is a deductible business expense, so reduces taxable business profit (and after 2017, the QBI deduction for those eligible). But you end up paying both halves if you own the business.
I did some of my own research and looks like there is no payroll tax on distributions.

So my revised math is this:

Increase in payroll tax from $30k salary to $45k salary = 15.3% x $15,000 = $2,294

Current $80,000 Profit subject to QBI Deduction = $16,000 Deduction x .22 bracket = $3,520 taxes saved

But if I run payroll up to $45,000 = $65,000 Profit Subject to QBI Deduction = $13,000 deduction x .22 bracket $2,860

$3,520 - $2,860 = $660

$2,294 (Increased Payroll Tax) + $660 (Difference in QBI) = $2,954

Doing the 401k max as employee = $19,500 x .22 bracket = $4,290

***

To me that is an extremely minor difference to lock up money in a 401k.

Seems like my best bet is to contribute as much as I can within the $30k salary, add employer contribution ($7,500), and then make sure I hit all the maxes next year.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

You would pay 15.3% payroll taxes on the increase in salary. Half of that would come out of the paycheck. The other half is a business expense so would reduce the profit subject to QBI deduction from $65k to $63853
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

nolesrule wrote: Thu Oct 14, 2021 1:09 pm You would pay 15.3% payroll taxes on the increase in salary. Half of that would come out of the paycheck. The other half is a business expense so would reduce the profit subject to QBI deduction from $65k to $63853
What do you make of the math in the post I provided above?

Seems to me that rushing to contribute at end of year is not the best idea. The tax savings are minimal, especially since I have to withdraw them eventually anyway.

Thanks again for your help.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

CoastLawyer2030 wrote: Thu Oct 14, 2021 1:10 pm
nolesrule wrote: Thu Oct 14, 2021 1:09 pm You would pay 15.3% payroll taxes on the increase in salary. Half of that would come out of the paycheck. The other half is a business expense so would reduce the profit subject to QBI deduction from $65k to $63853
What do you make of the math in the post I provided above?

Seems to me that rushing to contribute at end of year is not the best idea. The tax savings are minimal, especially since I have to withdraw them eventually anyway.

Thanks again for your help.
I think you're letting the tax tail wag the dog. I'd be aiming to max out as much as possible. You can't get the space back. Additionally you are ignoring the possibility of an increased social security benefit. And you are optimizing for an end result based on current taxes this year instead of thinking about the long term.
Last edited by nolesrule on Thu Oct 14, 2021 1:16 pm, edited 1 time in total.
fyre4ce
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

CoastLawyer2030 wrote: Thu Oct 14, 2021 12:53 pm
fyre4ce wrote: Thu Oct 14, 2021 12:51 pm
CoastLawyer2030 wrote: Thu Oct 14, 2021 12:40 pm
fyre4ce wrote: Thu Oct 14, 2021 12:22 pm
You are only looking at half of the payroll tax. When you own your own business you have to pay both halves for wages you pay yourself.

Check out the spreadsheet I made in the other thread. It does this calculation exactly.
Yes, but I was subcontracting my salary payroll tax (15.3%) to my distribution payroll tax (7.65%), or am I screwing that up?
Sorry, I don't understand what "subcontracting [your] salary payroll tax" means. It might just be a terminology thing, or maybe an actual misunderstanding. May I suggest you read the wiki article on payroll tax? The employee half comes out of your paycheck automatically. The employer half also gets paid to the IRS, but is a deductible business expense, so reduces taxable business profit (and after 2017, the QBI deduction for those eligible). But you end up paying both halves if you own the business.
I meant subtracting.

What I am saying is that if I increase my salary to $45,000, I have to pay 15.3% payroll tax on that increase from my previous salary (from $30,000). But beyond that $30,000 anyway, I have to pay 7.65% payroll tax anyway, right? Or I don't pay any payroll tax on distributions?
Payroll tax only applies to wages. If you pay yourself a $30,000 salary, you will pay $2,295 (=$30k x 7.65%) out of your paycheck, which is not income tax-deductible, and also $2,295 from the business, which is effectively income tax-deductible because it reduces taxable business profits. Payroll tax is not assessed on business distributions, so it doesn't matter whether this business had a net profit of $35k or $350k, the payroll taxes are assessed only on the salary and would be the same in either case. But, paying a reduced salary to reduce payroll taxes is a well-known (to taxpayers and the IRS) tax avoidance strategy, which is why the IRS requires a "reasonable" salary, and also gives guidance that income from personal work should be ALL wages; distributions are only supposed to be for businesses that leverage capital and/or the labor of employees.

If you raised your salary from $30k to $45k, you would pay an extra $1147.50 payroll taxes as an employee, plus $1147.50 from the business. Your taxable income would be reduced by $1147.50, because the extra employer payroll tax is deductible, but you would also lose $229.50 of section 199A deduction. So your net change in total tax owed would be $2,295 - $918 x [your marginal tax rate on income].

Hope that helps.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

nolesrule wrote: Thu Oct 14, 2021 1:15 pm
CoastLawyer2030 wrote: Thu Oct 14, 2021 1:10 pm
nolesrule wrote: Thu Oct 14, 2021 1:09 pm You would pay 15.3% payroll taxes on the increase in salary. Half of that would come out of the paycheck. The other half is a business expense so would reduce the profit subject to QBI deduction from $65k to $63853
What do you make of the math in the post I provided above?

Seems to me that rushing to contribute at end of year is not the best idea. The tax savings are minimal, especially since I have to withdraw them eventually anyway.

Thanks again for your help.
I think you're letting the tax tail wag the dog. I'd be aiming to max out as much as possible. You can't get the space back. Additionally you are ignoring the possibility of an increased social security benefit. And you are optimizing for an end result based on current taxes this year instead of thinking about the long term.
I view this as the inverse -- I view contributing such a vast amount of money to save roughly $1,200 in net taxes to be letting the tax tail wag the dog.

If I put $27,000 in a 401k, that money is worth $205,000 in 30 years. I still likely have to pay some sort of income tax on it.

If I put $25,800 in a brokerage (the amount I'd have if I just eat the tax this year), that money is worth roughly $194,000 in 30 years (figuring in some tax drag on the dividends). But, now I don't owe any income tax on it. I theoretically could owe some capital gains tax on it, but that's only if I withdraw a substantial amount, which is doubtful.

I value the flexibility of just having cash on hand over maximizing tax space -- unless that tax space provides a huge difference. That is the case with my 457 contributions, or general 401k contributions (without raising my salary), etc. But it just does not seem to be the case here, where doing this requires raising my salary, thus paying more payroll tax, and thus reducing the QBI deduction.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by fyre4ce »

CoastLawyer2030 wrote: Thu Oct 14, 2021 1:56 pm
nolesrule wrote: Thu Oct 14, 2021 1:15 pm
CoastLawyer2030 wrote: Thu Oct 14, 2021 1:10 pm
nolesrule wrote: Thu Oct 14, 2021 1:09 pm You would pay 15.3% payroll taxes on the increase in salary. Half of that would come out of the paycheck. The other half is a business expense so would reduce the profit subject to QBI deduction from $65k to $63853
What do you make of the math in the post I provided above?

Seems to me that rushing to contribute at end of year is not the best idea. The tax savings are minimal, especially since I have to withdraw them eventually anyway.

Thanks again for your help.
I think you're letting the tax tail wag the dog. I'd be aiming to max out as much as possible. You can't get the space back. Additionally you are ignoring the possibility of an increased social security benefit. And you are optimizing for an end result based on current taxes this year instead of thinking about the long term.
I view this as the inverse -- I view contributing such a vast amount of money to save roughly $1,200 in net taxes to be letting the tax tail wag the dog.

If I put $27,000 in a 401k, that money is worth $205,000 in 30 years. I still likely have to pay some sort of income tax on it.

If I put $25,800 in a brokerage (the amount I'd have if I just eat the tax this year), that money is worth roughly $194,000 in 30 years (figuring in some tax drag on the dividends). But, now I don't owe any income tax on it. I theoretically could owe some capital gains tax on it, but that's only if I withdraw a substantial amount, which is doubtful.

I value the flexibility of just having cash on hand over maximizing tax space -- unless that tax space provides a huge difference. That is the case with my 457 contributions, or general 401k contributions (without raising my salary), etc. But it just does not seem to be the case here, where doing this requires raising my salary, thus paying more payroll tax, and thus reducing the QBI deduction.
I see a few problems here.

First, I don't think the math on your taxes today is correct. Your numbers indicate a net marginal tax rate of 4.4% (= $1,200 / $27,000) on pre-tax contributions. I would agree that if that were true, you should probably not make them, but I'm extremely skeptical that that's your actual tax impact. I would really encourage you to download and play around with this spreadsheet I made for a poster with a very similar question recently. It folds in all the relevant factors of payroll tax, QBI, tax savings of retirement accounts, etc and boils it all down to one number, the total future value. Spending 20 minutes playing around with that spreadsheet will be your fastest path to the right mathematical answer here, I think. If there's something there that's confusing, let me know by posting here or by PM.

I'm also still skeptical that a $30k salary is "reasonable" for the work you're doing given the business's receipts. Putting that aside, if you expect to have a similar salary over your working career, you're going to be in the 32% bracket for Social Security PIA payments, where you receive a substantial increase in future benefits for paying SS taxes. The approximate IRR for that situation is 0%, meaning you "get your money back" on SS taxes. So you could ignore the SS tax cost from your analysis entirely and consider only the 2.9% Medicare tax. That would be a better way to go.

There are also qualitative benefits of retirement accounts not fully captured by a simple future value calculation. Usually the time horizon is taken as the first year of retirement, when withdrawals start. But retirement accounts continue to grow tax-deferred or tax-free in retirement, which could be another 20-30 years, PLUS they get another 10 year stretch after your heirs inherit them. Retirement accounts give you space to make rebalancing trades without paying a tax cost. And they have asset protection benefits compared to a taxable account, which gets no special asset protection. I agree that taxable money has a liquidity advantage, but there are also a lot of ways to get money out of retirement accounts penalty-free before age 59.5 if you want to.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

fyre4ce wrote: Thu Oct 14, 2021 2:39 pmI see a few problems here.

First, I don't think the math on your taxes today is correct. Your numbers indicate a net marginal tax rate of 4.4% (= $1,200 / $27,000) on pre-tax contributions. I would agree that if that were true, you should probably not make them, but I'm extremely skeptical that that's your actual tax impact. I would really encourage you to download and play around with this spreadsheet I made for a poster with a very similar question recently. It folds in all the relevant factors of payroll tax, QBI, tax savings of retirement accounts, etc and boils it all down to one number, the total future value. Spending 20 minutes playing around with that spreadsheet will be your fastest path to the right mathematical answer here, I think. If there's something there that's confusing, let me know by posting here or by PM.
My numbers are the *net* difference in total taxes, which as you say, might not be right.

I will try the spreadsheet but I have contacted my CPA to plug in all my potential numbers and spit out the total taxes under the scenarios discussed in this thread.

It would not be the first or last time I am proven wrong.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

It may not be that far off because of paying the extra payroll tax in order to make the full contribution while saving on income tax.

That said, if that's close to the marginal actual calculated marginal rate I'd still give myself the salary increase and go Roth if your plan supports Roth contributions rather than forgoing maxing out the employee 401k contributions entirely. I don't think drawing the larger salary this one year is that big a deal and worth it to put the money in Roth. And I'd still make the employer contributions.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by foolio97 »

Regarding the Solo 401k employER contribution, recommend either: (a) make your CY2021 contribution when you complete your CY2021 taxes next year (2022) or (b) make an (estimated) 50% contribution sometime in CY2021 and make the remaining ~50% contribution next year (2022) when you do your taxes. If you over contribute to a solo 401k as the employER, it is rather painful to correct it.

I believe that you need to make the CY2021 employEE contributions before the end of CY2021 but the employER contribution can be made up until the CY2021 tax deadline (4/15/2022?), or longer if you file an extension.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by CoastLawyer2030 »

foolio97 wrote: Fri Oct 15, 2021 12:00 am Regarding the Solo 401k employER contribution, recommend either: (a) make your CY2021 contribution when you complete your CY2021 taxes next year (2022) or (b) make an (estimated) 50% contribution sometime in CY2021 and make the remaining ~50% contribution next year (2022) when you do your taxes. If you over contribute to a solo 401k as the employER, it is rather painful to correct it.

I believe that you need to make the CY2021 employEE contributions before the end of CY2021 but the employER contribution can be made up until the CY2021 tax deadline (4/15/2022?), or longer if you file an extension.
God this is such a great website. Thanks for the insight. I always assumed the employER contributions had to be due by EOY just like all other 401k contributions.
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Re: Solo 401k -- How it Affects Payroll Tax, QBI Deduction, and Whether to Contribute as EE or ER

Post by nolesrule »

The deadline for employER contribution in an S-Corp is based on S-Corp filing dates, not individual filing dates. That would be March 15 (or Sept 15th with extension)
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