Before the year ends, one thing I have been doing a lot of is year end business planning. I have a lot of entertainment and professional clients with S Corporations that need a sitdown meeting to decide how much compensation they need to take to meet the reasonable compensation rules, plus they have solo 401K retirement plans that they want to contribute to. This is where a decision has to be made – take the absolute minimum reasonable compensation (I have software that can calculate a compensation amount) and possibly forgo some 401K contributions.

If my clients want to maximize their 401K contributions, they will need to take $134,000 in wages (the passthrough profit on the S Corporation K-1 doesn’t count) to get the maximum 25% employer contribution of $33,500 (134,000 x 25%). That plus the $17,500 maximum employee deferral ($23,000 if over 50) gets them the maximum contribution of $51,000 ($56,500 if over 50). The offshoot is that on the first $113,700 of wages the client will owe 15.3% of social security tax (12.4% FICA and 2.9% Medicare) but will get a tax savings on all the 401K contributions (if a California resident probably a third of the contribution.)

Say the California client decided on a reasonable compensation of $120,000. It would cost him payroll taxes of about $18,500 (including California SDI) but making the $17,500 employee deferral plus the 25% employer contribution of $30,000 will save him taxes of about $15,833 ($47,500 times a third.) So this amount may not be the best. That is why each planning session is different and I go over different situations with the client.

If you have this issue, call or email me and we can talk about it.

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