Solo 401k - Sole Proprietorship vs. S-Corp

[Michael16]

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?

[Anonymous_]

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]

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@Michael16 wrote:

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

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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)

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[Rick19744 · Accepted solution]

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.

[Michael16]

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

[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/