I posted this on bheads and someone advised I post here as there are actual CPAs that may be able to advise. Here it is!
Our current setup:
Spouse 1: Partner in a practice setup as S corp and gets W2 income. There is a 401k setup here where employEE max contribution is made. EmployER then matches based on productivity like 6-7K/year – let’s say total was $25K for 2016. Also, has single member LLC taxed as sole proprietor set up, into which additional consulting income flows. There is also a corresponding solo 401K setup for the consulting income. Only profit sharing goes into the solo 401K.
Question: In this case, does the 7K match from employER, count towards the $53K limit for this 401K? I am not sure about this
Spouse 2: Employed position with a W2 salary and access to 401K, 401a, and 403b, which are all being maxed. Also transitioning into the consulting arena and now has EIN number from IRS and getting some 1099 income. No solo 401K setup yet. No LLC. Just working as a sole proprietor.
Does it make sense to ADD Spouse 2 to the already made LLC and solo 401K or to open separate? Adding spouse to LLC means filing partnership returns with IRS and amending State agreement. Not adding means filing additional schedule C.
I am also debating moving towards S corp. Trying to figure out what IRS considers reasonable compensation. For example: Assume we are both Family Practice physicians and earn 225k/year, which is reflected in our W2 from the respective employers. Assume, this consulting we are now both doing brings in another $300K. Can we take the majority of the consulting income as distribution? I mean we are already making reasonable compensation as FP docs from W2 and, heck, can even pay ourselves 25K in salary each from the S corp. That will still leave 250K in distributions and tax savings. Correct?
Looking for feedback and how to maneuver moving forward for 2017. Thanks all.March 25, 2017 at 8:27 pm MST #41344jfoxcpacfpModeratorStatus: Financial Advisor, Accountant, Small Business OwnerPosts: 8137Joined: 01/09/2016
This is, like, a 1 – 2 hour consult with a CPA. I sure hope you’re not self-preparing your returns. I’ll offer some general advice.
March 26, 2017 at 5:00 am MST #41370
- Correction, the limit is $54k. Assuming spouse1 is only employed at the S-corp, spouse1 can contribute another $54k as profit sharing to solo-k of the S-corp.
- Since spouse1 already has access to a separate s-corp, I see no additional benefit of adding S1 to your LLC.
- No, you should NOT take the majority of consulting income as distribution. That is, unless the consulting income is not from the fruits of your labors. That would be quite a feat, I suppose, but, in that case, you can take the $ as distributions, which is, in effect, the remaining profits generated by the business beyond your own efforts. For all practical purposes, the rule in our office, which the IRS has, so far, accepted, is for distributions to not exceed salary. Afaik, this is probably the most commonly-used guideline for s-corp dist’s in our profession.
To clarify, Spouse 1 wears two hats:
1) partner in a practice that is setup as a S corp, with its own 401k
2) sole owner of LLC setup as a sole proprietorship, with its own solo 401k – gets paid 1099
From what I understand, you get a separate $54K limit for each unrelated employer, but only one $18K employEE contribution no matter how many employers. Correct?
Spouse 2: employee in a practice, W2 payroll with access to 403(b) plan, 457(b) plan, and some other pre-tax contributions.
Spouse 2 is now also starting to getting into the 1099 arena and will have some income coming in 2017. I guess what I am asking is if Spouse 2 should piggyback onto Hat 2 of Spouse 2 i.e. be added to the LLC and the solo 401K VERSUS opening another solo 401K?
S corp – “For all practical purposes, the rule in our office, which the IRS has, so far, accepted, is for distributions to not exceed salary.”
Do you mean salary stemming from the S corp consulting or salaries in general from all factors? Assuming S corp/1099 income is 300K, can we take 100K as salary and 200K distributions? Is there a break even point where it makes sense to pay the extra $ and hassle to run a S corp in order to save taxes via distributions?March 26, 2017 at 7:24 am MST #41385
The W-2 compensation from your primary occupation has nothing to do with reasonable compensation for the S-Corp. The IRS guidance is somewhat vague, but they are very clear about minimum compensation for the S-Corp’s shareholder-employees providing providing mostly services. This is where the 50% + $1 rule that Johanna referenced and many CPAs use. In fact many feel it is the most aggressive position possible and still meet the guidance.
IRS: “If most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be allocated as compensation.”
With that said an S-Corp is counter-productive for most physicians moonlighting income. This is because all corporations are required to deduct the Social Security (SS) component (12.4%) of FICA on all W-2 employees up to the SS max wage base (2017 = $127,200). Most all physicians will earn more than this amount in their primary W-2 employment, while the S-Corp employee share (6.2%) can be refunded on Form 1040, the employer share is not recoverable.
However, for a sole proprietor on Schedule SE the other W-2 earnings >= the SS max wage base will result in no amount of the net profits being subject to the SS component of the SE tax.
So let us do an example with the lowest salary reasonable salary on $300,000 = $150,000. You will actually pay more than $2K extra in S-Corp FICA than a sole proprietor will pay in SE tax.
S-Corp FICA taxes with $225,000 primary W-2 salary and S-Corp W-2 salary $150,000
Social Security FICA employer component (12.4%) = $127,200 * 12.4%% = $15,772
Medicare FICA employer/employee component (2.9%) = $150,000 * 2.9% = $4,350
Medicare FICA surtax employee component (0.9%) = $225,000 + $150,00 – $250,000 = $125,000 * 0.9% = $1,125
S-Corp Total = $15,772 – ($15,772/2 = $7,937) + $4,350 + $1,125 = $13,361
Sole proprietor SE taxes with $225,000 primary W-2 salary and sole proprietorship net self-employment income $300,000
Social Security SE component (12.4%) = $0 * 12.4% = $0
Medicare FICA employer/employee component (2.9%) = $300,000 * 2.9% = $8,700
Medicare FICA surtax employee component (0.9%) = $225,000 + $300,000 – $250,000 = $275,000 * 0.9% = $2,475
Sole proprietor Total = $8,700 + $2,475 = $11,175March 26, 2017 at 8:51 pm MST #41502jfoxcpacfpModeratorStatus: Financial Advisor, Accountant, Small Business OwnerPosts: 8137Joined: 01/09/2016
I could have saved you some time. An s-corp is counterproductive for most physicians’ moonlighting income and for many physicians’ primary income because of the additional cost for compliance. Unless the physician has other employees (as in, running an office), the cost of payroll preparation and annual tax filing overrides the taxes saved for the sole practitioner until s/he hits at least $350k – $400k gross or more. Otherwise, a LLC or sole proprietorship is usually better. Speaking in generalities, of course.March 27, 2017 at 6:32 am MST #41520
Spirit Rider! Is that you from there yonder? Thanks again for chiming in and thank you jfox as well. I will go back over those calculations and try to make sense out of them. Is there a “break even” income point when S corp does make sense for a couple if they don’t plan to hire employees?
So, in my case, it seems we should just stick with what we have i.e. no S corp. Does it make sense to add Spouse 2 to the already formed LLC and the already formed solo 401k? Or should Spouse 2 re-create the setup, maybe w/o the LLC as that was just done to be done, as it serves no purpose?March 27, 2017 at 2:37 pm MST #41607
There is seldom a case where an S-Corp makes sense for moonlighting income where only the personal services of the physician generates revenue. As Johanna pointed out, you generally need to get to about $400K before break even, not counting administrative costs.
The only time an S-Corp for moonlighting generally makes sense is when you can leverage your services for revenue. This requires a revenue stream from employees, capital, equipment, etc… For example, this website generates a significant multiplier from the services provided by WCI. He can legitimately claim a much lower reasonable salary than would someone just providing personal services for the same amount of revenue.
I would just have her use a sole proprietorship and make sure there is adequate malpractice and business liability insurance. If you were in a community property state you could use the LLC for a qualified joint venture. This is essentially a simplified partnership without the need to modify the LLC to a multi-member and file a partnership return with K-1s. That would still require the filing of two Schedule C/SEs and I’m not sure that would provide any real advantage.
Maybe Johanna can give her expert opinion on the best non-corporate business entity for you/her with this fact pattern.March 27, 2017 at 3:51 pm MST #41610
Thanks. Let’see what Johanna saysMarch 28, 2017 at 3:34 pm MST #41696jfoxcpacfpModeratorStatus: Financial Advisor, Accountant, Small Business OwnerPosts: 8137Joined: 01/09/2016Maybe Johanna can give her expert opinion on the best non-corporate business entity for you/her with this fact pattern.Click to expand…
I thought you were doing a fabulous job on your own :-). I agree with the sole proprietorships. You’ll save money on registration and annual filing fees at the state level, have access to the same amount of retirement benefits (contrary to popular opinion), and, unless your consulting income is not covered by your malpractice insurance (not sure at this point), have no liability unless due to some random event such as if a client/patient visits your home office and slips on your steps and breaks his neck. But your homeowner’s/umbrella insurance (you do have adequate umbrella insurance, don’t you?) would cover that.
Of course, if you want the comfy feeling of an added cushion of protection that an LLC gives you, go for it. You’ll pay set up fees and whatever annual/biannual fees are in your state of operation and any other states where you have nexus. Be sure to check with your malpractice carrier, just to be sure, though.March 29, 2017 at 5:14 am MST #41742
No malpractice or liability issues that I know of. Umbrella is in place.
If I add spouse to already formed LLC and make it a partnership, can we split all of our combined 1099 income equally? I don’t think spouse will hit the threshold alone to max out profit sharing in a solo 401k, but, if we combine, we may be able to both max out profit sharing.
Also in regard to solo 401k – add the spouse to the already open one or open one for spouse at Fido?April 1, 2017 at 6:03 am MST #42093
First, are you in a community property state? If you are, you can use a qualified joint venture instead of a partnership. It serves the same purpose without the need to modify the LLC and file a partnership return.
Whether it is a partnership or qualified joint venture, in order to apportion the net business profits, the relevant partners must materially participate in the partnership. See the rules under passive/active participation. Regardless of who gets what portion of the net self-employment income, it does not change the amount of the maximum employer’s contribution. It only allocates it differently.
Let’s take two examples where the partnership generates $300K in net profits. I am leaving out the SE tax calculation for simplification because it changes based on income. In the first case partner #1 receives 90%, $270K and a $54K employer contribution, partner #2 receives 10%, $30K and a $6K employer contribution. Int the second case, both partner #1 and partner #2 each receive 50%, $150K and a $30K employer contribution. You will note in both cases the employer (partnership) makes employer contributions of $60K and the two partners (#1 and #2) receive a combined $60K employer contribution.
Where splitting the income really helps is when one spouse does not have access to a 401k/403b and is able to make both am employee deferral and receive a 20% employer contribution. To take maximum advantage of all contributions requires a minimum income of $30K ($40K >= age 50) for self-employed individuals.
If you end up with a same business entity, either you change to a two member LLC defaulted as a partnership or continue the current single member LLC defaulted to as a sole proprietorship, electing to be treated as a qualified joint venture in a community property state. Then she can simply be added to the Solo 401k as another owner-employee.
If she continues to use her own business, she will need to adopt her own Solo 401k. Personally, I’m not really seeing any benefit of adding her income to the LLC other than to avoid opening her own Solo 401k. In either case it is still her own 401k account, whether at her Solo 401k or your LLC’s 401k.
P.S. I guess adding her to your LLC as someone who materially participates captures employer contributions on amounts you generate that would be above the annual addition limit (2017 = $54K. So right now, you lose the ability to make contributions on amounts that would push your net self-employment income above $270K.April 1, 2017 at 2:39 pm MST #42137