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Business savvy friends (s Corp question)

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  • Business savvy friends (s Corp question)

    My husband has a side business that is structured as an S corp that he owns with 3 partners. Thus far it's basically been a hobby but the business will have about 100k profit this year. Is there a way for this money to just go into a tax protected retirement account for each of them? He and partners will discuss with accountant of course but I'm impatient and want to know now;-) If the other partners wanted it paid out as a salary but my husband wanted it to go to retirement, is that a thing? I could see the others just wanting cash but at our income level we'd get to keep way more if it could go into a tax protected space. Any thoughts are appreciated, I really have no understanding of business structures but I know others on here have LLCs and S corps and such.

  • #2
    Why they chose an S-Corp with so very little profit is beyond me. Especially, if their W-2 wages from all sources are >= the SS maximum wage base (2019 = $132,900). If so, the S-Corp will cost them more in net FICA taxes than they would have paid as SE taxes in a partnership. An LLC is a state chartered business entity, not an IRS tax structure.

    The S-Corp employee elective contributions are limited in 2019 to $19K - the employee elective contributions of that individual to other employer plans. They can not exceed and must be deducted from the net (less mandatory deductions; FICA etc...) W-2 compensation they receive with a pay date on or before 12/31. Each employee can elect what employee elective contribution to make. This election must come before any employee elective contributions and must come from W-2 compensation not already received.

    S-Corp employer contributions are limited to 25% of W-2 compensation. The combined employee + employer annual additions can not exceed the lessor of their W-2 compensation or the annual addition limit (2019 = $56K). Each employee must receive the same exact employer contribution percentage. All or none.

    The employee's share of the S-Corp's ordinary business income is not compensation, is considered passive income and is never eligible for retirement contributions.

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    • #3




      Why they chose an S-Corp with so very little profit is beyond me. Especially, if their W-2 wages from all sources are >= the SS maximum wage base (2019 = $132,900). If so, the S-Corp will cost them more in net FICA taxes than they would have paid as SE taxes in a partnership. An LLC is a state chartered business entity, not an IRS tax structure.

      The S-Corp employee elective contributions are limited in 2019 to $19K – the employee elective contributions of that individual to other employer plans. They can not exceed and must be deducted from the net (less mandatory deductions; FICA etc…) W-2 compensation they receive with a pay date on or before 12/31. Each employee can elect what employee elective contribution to make. This election must come before any employee elective contributions and must come from W-2 compensation not already received.

      S-Corp employer contributions are limited to 25% of W-2 compensation. The combined employee + employer annual additions can not exceed the lessor of their W-2 compensation or the annual addition limit (2019 = $56K). Each employee must receive the same exact employer contribution percentage. All or none.

      The employee’s share of the S-Corp’s ordinary business income is not compensation, is considered passive income and is never eligible for retirement contributions.
      Click to expand...


      Thanks for the response! I've read it several times and I think I might understand it,  or at least some of it ?

       

      My husband's w2 earnings exceed 132k/ year but I don't think the other partners do ( and my husband's did not when they formed the s Corp 7 years ago). So that might be why they chose the s corp.

       

      It sounds like you are saying that since my husband already contributes 19k into his main job's 401k, he can't contribute any more than this through the s Corp. But if his company pays him and the 3 partners  each 20k in w2 wages, the S Corp could then contribute 5k into a retirement plan for each of them? Let me know if I'm reading that wrong.

       

      And finally it sounds like the other option would be to disburse the money equally among the 4 of them as ordinary businesses income which would be taxed at the 25% rate?

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      • #4




        And finally it sounds like the other option would be to disburse the money equally among the 4 of them as ordinary businesses income which would be taxed at the 25% rate?
        Click to expand...


        An S-corp is pass through. You can distribute money to the owners but it is taxed as ordinary income (except for FICA).

        edit: Or more accurately the owners of the company pay ordinary income tax on any profits the company generates.

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        • #5







          And finally it sounds like the other option would be to disburse the money equally among the 4 of them as ordinary businesses income which would be taxed at the 25% rate?
          Click to expand…


          An S-corp is pass through. You can distribute money to the owners but it is taxed as ordinary income (except for FICA).

          edit: Or more accurately the owners of the company pay ordinary income tax on any profits the company generates.
          Click to expand...


          I thought the rate was 25% for pass through businesses?

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          • #6
            I don't know where you got the 25% tax rate. There is no longer even a 25% tax bracket.

            An S-Corp shareholder-employee's W-2 wages and their share of an S-Corp's ordinary business income are both taxed just like any of ordinary income at the shareholder-employee's marginal tax rates

            The only thing that is 25% is the maximum employer contribution percentage.

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            • #7
              I thought the good thing about pass through was that the income was taxed at a lower rate, and that rate was 25%. In the tax bill that passed last year or so. But clearly I am confused! In which case I am wondering what is so great about pass through income? It sounds like it's the same as any other income.

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              • #8
                Pass-thru income essentially means that the vast majority of the business income is taxable to the pass-thru owner at ordinary income tax rates and not the business as in a C-Corp and then again as dividends.

                This used to be far more beneficial when the corporate tax rate was 35% and all dividends were subject to ordinary income tax rates.

                Comment


                • #9




                  I thought the good thing about pass through was that the income was taxed at a lower rate, and that rate was 25%. In the tax bill that passed last year or so. But clearly I am confused! In which case I am wondering what is so great about pass through income? It sounds like it’s the same as any other income.
                  Click to expand...


                  The recent tax bill (tax cuts and jobs act) did add qualified business income deduction which applies to s corps (as well as partnerships and SP). It is a 20% deduction on QBI so still not sure where 25% came from.

                  For many people there is nothing great about pass through income. Often people create an s corp with no significant benefit (because someone told them they should). For some avoiding paying the 3.8% (1.45% employee + 1.45% employer + 0.9% ACA) medicare tax is worth it.

                   

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                  • #10




                    I thought the good thing about pass through was that the income was taxed at a lower rate, and that rate was 25%. In the tax bill that passed last year or so. But clearly I am confused! In which case I am wondering what is so great about pass through income? It sounds like it’s the same as any other income.
                    Click to expand...


                    As @spiritrider said, the 25% rate is no longer relevant. To answer your question:

                    • ”Distributions” (i.e. the income that is “passed through”) are not taxable for FICA purposes. Since most physicians are already above the SS wage base of $132,900 (2019), all they will save is Medicare taxes of 2.9% + .9% additional Medicare Tax

                    • Pass-through businesses also qualify for the 199A deduction if the taxpayer’s income is below the thresholds. This is not as beneficial as it might sound because a sole proprietorship/partnership is also a pass-through entity. As an S-corp, the deduction is even more limited than it is for sole props/partnerships, so this point is only for information purposes.


                    In summary, at certain income thresholds, an s-corp can make sense because the Medicare taxes can make a significant difference. However, you need to have income allocated to yourself of (impo) ~$350k - $400k per person. This gets quite complicated because of the 199a deduction and the spouse’s income must be considered.

                    In your hubs’ situation, I totally agree with @spiritrider - the s-corp is illogical. But in other situations, it may make sense. You really need to work with an experienced CPA to go through the numbers and scenarios. Unfortunately, I cannot say I have a lot of confidence in the current CPA. Of course, there may be other facts we don’t know and are not considering.
                    Financial planning, investment management and CPA services for medical professionals | 270-247-6087

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                    • #11




                      Each employee must receive the same exact employer contribution percentage. All or none.


                      Not that it really matters in this case, where salary for shareholders seems to be low, or nonexistent.

                      But I don’t think this has to be the case for an S Corp where all the employees are also shareholders. All the shareholders would be “highly compensated employees” based on their ownership.

                      You could probably setup a cross tested plan with non equal profit sharing allocations.

                      Comment


                      • #12
                        Thanks everyone! The partnership consists of 4 tech people, so they are not strong on the business side of things, which has long frustrated me. I don't really trust the cpa which is why I wanted opinions and now I understand things better. So thank you!

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                        • #13
                          if they are all on board a SEP IRA would be great here

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