Solo 401k - Sole Proprietorship vs. S-Corp

Forum|Forum|3 years ago
January 12, 2023
4 replies
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I'm currently a sole proprietor for a consulting business (I am the sole owner with no employees). I'm wanting to compare the difference in taxes between being a sole proprietor and being an S-Corp. I understand for a simple business like mine, being a sole proprietor is often the most tax efficient and simplest route.

For sake of this discussion, here are some fictitious numbers:

SOLE PROPRIETOR
Net profit (gross receipts minus expenses): $325,000
Self-employment tax: ($325,000*0.9235)*0.153=$45,921
Solo 401k Max: (($325,000-(0.5*$45,921))*0.2=$60,407 (less than $66,000 IRS max)
Employee deferred: $22,500
Employer contribution: $60,407-$22,500=$37,907
QBI Deduction: ($325,000-$45,921)*0.2=$55,816

S-CORP
Net profit (gross receipts minus expenses): $325,000
Salary/wages: $130,000
Employer FICA contribution: $130,000*0.0765=$9,945
Employee deferred: $22,500
Employer contribution: $130,000*0.2=$26,000
S-Corp distribution: $325,000-$130,000-$9,945-$26,000=$159,055
QBI Deduction: ($159,055-$48,500)*0.2=$22,111

Do these calculations based on the assumptions made look accurate? I assume both wages and distribution as an S-Corp are taxed as ordinary income?

TurboTax Business Windows

Best answer by Rick19744

While you may want to compare the "taxes" between the two entity types, you really need to look at this from a longer term perspective, and as such, you should sit down with a tax professional and model this out:

We don't know what type of business you are operating
You need to consider liability issues that may occur and which structure minimizes any risk to you
The business type will impact a "reasonable" salary requirement at the S corporation level. This is a hot topic as an audit issue with the IRS.
I believe your sole proprietorship example didn't factor in the 2.9% unlimited Medicare tax component
You need to consider the benefit of the basis build up that the S corp may provide upon an eventual sale of the business
Does a Roth IRA make more sense to you long term

This forum is helpful in a number of situations, but is not beneficial in a situation such as this that is better served with an in-person consultation. This is like trying to do the same thing as texting.....just doesn't work efficiently.

Anonymous_

Employee

I will page Champ @Rick19744, but you should initially understand the difference between a distribution and net business income (you are subject to income tax on the latter while the former reduces your basis of your shares of the corporation).

Further, for a consulting (essentially 100% service) business, your salary is rather low in your S corporation calculation and the figure you have listed as a "distribution" could very well be subject to recharacterization by the IRS as salary (in part of whole).

AmeliesUncle

@Michael16 wrote:

Self-employment tax: ($325,000*0.9235)*0.153=$45,921

No. Social Security maxes out at $147,000 (2022).

Self-employment tax: ($147,000*0.9235)*0.153 [Social Security and Medicare] + $178,000*.9235*.029 [Medicare only] = $25,537

And don't forgot that the corporation salary will have both employee FICA and employer FICA ( a total of $19,890 in your example, but as was mentioned that salary seems low if you don't have anybody working for you)

Michael16Author

Thanks. Does the additional 0.9% Medicare tax factor into this for MFJ with income over $250k?

DanaB27

Yes, a 0.9% Additional Medicare Tax applies to Medicare wages and self-employment income that exceeds threshold amounts based on your filing status: $250,000 for married filing jointly.

For more information please see Additional Medicare Tax

@Michael16

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Rick19744Answer

Employee

We don't know what type of business you are operating
You need to consider liability issues that may occur and which structure minimizes any risk to you
The business type will impact a "reasonable" salary requirement at the S corporation level. This is a hot topic as an audit issue with the IRS.
I believe your sole proprietorship example didn't factor in the 2.9% unlimited Medicare tax component
You need to consider the benefit of the basis build up that the S corp may provide upon an eventual sale of the business
Does a Roth IRA make more sense to you long term

*A reminder that posts in a forum such as this do not constitute tax advice.Also keep in mind the date of replies, as tax law changes.

anon-user

As written in your SOLE PROPRIETOR section, I'm pretty sure you have a misunderstanding of the Solo 401(k) 415(c) limit ("Solo 401(k) Max") and maximum employer profit sharing ("Employer contribution"). Also your QBI deduction calculation. Didn't look beyond that.

These may help clarify:

https://ira123.com/solo-401k-contribution-limits/

https://www.fool.com/the-ascent/small-business/document-management/articles/s-corp-vs-llc/