W-2 has 0 in Box 1, but $400 in Box 2. Is this correct?

[pencil123]

Hi, I'm preparing 2020 W-2 for my small S-Corp. I'm the owner and employee. I contributed all of my 2020 salary to Solo 401K, so my W-2 Box 1 is 0. However, I did withhold $400 federal income tax from my paycheck through 2020, thinking that I'll be able to get that refunded with I file my tax return. So my W-2 Box 2 is $400. When I use TurboTax Business to prepare my W-2, it won't allow me to enter a number greater than 0 for Box 2. What should I do? I'm worried that I won't be able to get my federal income tax withholding refunded.

Thanks for your help!

[Mike9241]

you have made a grave error.  if your compensation is $400 and you contributed it to a 401(K) plan there is no compensation left for you to have withholding. you are in effect ending up with a negative paycheck which is not possible. in addition, you have no money left to pay your share of fica and medicare taxes. 

you're probably going to need a pro to fix your w-2, 941, and make sure the S-Corp return reflects everything properly. you may also need to have any state Unemployment Compensation returns fixed.

if you made this error, what other errors!  this sounds like it's the first year for the S-Corp.  you should really use a pro to prepare the first-year return because things that are wrong or out of whack can generate an IRS audit which can end up costing you a lot more than what a pro would charge. then next year you could switch to TT business. No need to tell the pro that.  

for example, does or will the S-Corp return show a loss?  if so do you have enough tax basis to deduct it on your personal return. 

[pencil123]

Thanks a lot for your detailed response, @Mike9241! Really appreciate it. We'll definitely get help from an accountant. You mentioned that we may need to get our "state Unemployment Compensation returns" fixed. Is that for people who collected unemployment benefits in 2020? 

[Mike9241]

no. the State UC is just another payroll tax return that some states require businesses to file. in those states some have a minimum payroll before filing is required, your pro should know, 

[Opus 17]

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@pencil123 wrote:

Thanks a lot for your detailed response, @Mike9241! Really appreciate it. We'll definitely get help from an accountant. You mentioned that we may need to get our "state Unemployment Compensation returns" fixed. Is that for people who collected unemployment benefits in 2020? 

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Mike's answer may be incorrect.  What do you have for box 3 and 5?

401k contributions are only subtracted from box 1 wages subject to income tax.  Your wages are still subject to social security and medicare tax because they are still earned income.  (For example, if my gross salary is $50,000 and I contribute $26,000 to a 401(k), my box 1 wages would be $24,000 but my box 3 and box 5 wages would be $50,000.)

Having box 1 zero is not necessarily wrong, even for the owner of an S-corp, as long as you have earned income in box 3 and box 5 and your earned income is fair compensation for the work you performed.

I want to refer this to other experts @rjs @Hal_Al @dmertz 

[rjs]

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@Opus 17 wrote:

Having box 1 zero is not necessarily wrong 

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It's true that box 1 could be zero, but in the original question pencil123 said "I contributed all of my 2020 salary to Solo 401K..." So the S corp paid him, say $20,000, and he contributed the whole $20,000 to his 401(k), so box 1 is zero. But he also said he withheld $400 for federal income tax. Where did the $400 come from? There's no money left after the 401(k) contribution. I think Mike9241 is right. It doesn't work. Box 2 can't be more than box 1.

[Opus 17]

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@rjs wrote:

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@Opus 17 wrote:

Having box 1 zero is not necessarily wrong 

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It's true that box 1 could be zero, but in the original question pencil123 said "I contributed all of my 2020 salary to Solo 401K..." So the S corp paid him, say $20,000, and he contributed the whole $20,000 to his 401(k), so box 1 is zero. But he also said he withheld $400 for federal income tax. Where did the $400 come from? There's no money left after the 401(k) contribution. I think Mike9241 is right. It doesn't work. Box 2 can't be more than box 1.

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OK, I think I follow now.

If the taxpayer paid themselves $25,000 of earned income (box 3 and 5), they would have to withhold $1550 in social security tax and $362.50 in Medicare tax.  If they also withheld $400 of Federal income tax, the most they could have contributed to the 401(k) (to show zero in box 1) would have been $22,687.50.

And of course, they must have paid themselves at least a fair wage for the work performed.

Possibly they can issue themselves a corrected W-2 that takes account of Federal, FICA and Medicare withholding so that everything adds up correctly. 

[dmertz]

I agree that the amount in box 1 of the W-2 cannot be less than the the sum of the amounts in boxes 2, 4 and 6.  Tax withholding cannot come from an amount that was contributed to the 401(k) because that money is in the 401(k).  Also, $400 of income tax withholding seems like a suspiciously round number that seems unlikely to have been properly calculated based on wages and the Form W-4 in effect for calculating income tax withholding.

I've tried to think through the possible ways to correct this, but there seems to be no easy solution.  The first thing I thought of would be to treat the the sum of the income tax withholding, Social Security tax withholding and Medicare tax withholding as an excess contribution to the 401(k).  This excess would have returned from the 401(k) and paid back to the S corp, probably the easiest solution.  If instead the wages are increased, Social Security and Medicare taxes would need to be recalculated and the additional amounts paid, so the increase in wages would have to cover not only the $400 of income tax withholding but also the increases in Social Security and Medicare taxes.  Regardless of what is done, the W-2 would have to be corrected.

[fanfare]

did you literally/really  pay $400 to Treasury as withholding for an employee ?

[pencil123]

Thanks for the reply, @dmertz @Opus 17 @rjs! For some more context, here are the numbers of my other W-2 boxes (btw, I haven't submitted the W-2 yet, so I can still correct it.):

• Box 2: 430.20
• Box 3 and Box 5: 13,334
• Box 4: 826.70
• Box 6: 193.34

The mistake I made was I calculated my income tax withholding for Form 941 based on my entire gross pay (without first deducting the 401K contribution from my gross pay). If I had, my Box 2 would have been 0 because I contributed all my salary to pre-tax 401K. I withheld the 7.65% Social Security and Medicare taxes as required.

I thought the maximum 401K contribution is 100% of pre-tax gross pay, which would be $13,334 in my case. So that's the amount I contributed to my 401K. Is the maximum actually supposed to 100% of (gross pay - 7.65% FICA tax)?

To correct my current situation, is it ok if I keep my Form 941 income tax withholding of $430.20 as is (that's what I currently have in W-2 Box 2), and at the same time correct my 2020 401K contribution to be (gross pay - Box 2 - Box 4 - Box 6)? After this correction, my W-2 Box 1 will be the sum of Boxes 2, 4 and 6.

Thanks a lot for your help!

[Opus 17]

It’s not quite that simple because any change in box 1 will cause changes to all boxes 2-6.  It will probably be impossible to figure it so that your box 1 taxable wages are exactly zero.  

Firstly, how do you determine your fair market wages were $13,334?  Second, I assume that $13,334 is the amount you contributed to the 401(k) and that can’t easily be changed?

[pencil123]

Thanks for getting back to me @Opus 17 ! My 401k administrator says there is a way to correct the 401K contribution made for 2020. So maybe I can keep everything else the same and correct my 401K contribution to be (gross pay - Box 2 - Box 3 - Box 4)? I can change W-2 Box 1 since I haven't submitted the W-2 yet.

[pencil123]

Hi @fanfare, the withholding was a little over $400, not $400 exact. I just used the round number in my question to simplify things, but sounds like it caused confusions instead. My bad.

[dmertz]

The statutory limit for additions is 100% of compensation, but since the employee portion of FICA must be paid from the gross pay, that's money that is unavailable to defer to the 401(k), just as income tax withholding is unavailable to defer.  The limit for deferral ends up being gross pay minus all of the withholding.  The 100%-of-compensation limit comes into play when the employer contribution is factored in.  Your elective deferral plus the employer contribution is not permitted to exceed 100% of compensation.

That actually suggests a simple fix as long as no employer contribution has yet been made.  With $13,334 of compensation, subtracting from that the $1,450.24 of total tax withholding means that your maximum elective deferral to the 401(k) was $11,883.76.  Assuming that you are the only employee, what is now a $1,450.24 excess elective deferral might be able to be re-designated as the employer contribution (and would be the maximum permissible employer contribution).  Then all you would need to do is correct box 1 and the amount shown with code D in box 12 of the W-2.

Otherwise, $1,450.24 needs to be distributed and generally returned to the S corp.  Unless the plan can distribute it directly to the S corp in a way that is nonreportable, this $1,450.24 would likely be reported on a Form 1099-R as taxable to you.  Because it's under $3,000, if paid to you and you reimburse the S corp, you can't deduct it or claim a tax credit under a claim of right.  However, instead of returning the $1,450.24 to the S corp, the S corp might be able to deduct the repayment after tax from your 2021 compensation; that would means that the $1,450.24 would appear as part of your 2021 compensation.  The amount that would actually be distributed from the 401(k) would be adjusted for any investment gain or loss while in the 401(k).

[pencil123]

Thank you so much for the detailed explanation, @dmertz! I really appreciate it. I haven't made any employer contribution, so I'll check with my 401k plan administrator tomorrow to see if the excess elective deferral can be re-designated as an employer contribution. There are actually two co-owners/employees in our S-Corp and we both need to adjust our 401K contributions. Does that make a difference compared to a single owner/employee?

If I re-designate the $1,450.24 excess elective deferral, does the S-Corp need to reimburse me for $1,450.24 because I made that contribution from my personal bank account, not from the business bank account? If so, does that reimbursement count as a business expense reimbursement for the 2020 tax year? I'm just a little confused about how the separation of bank accounts and the accounting would work.

Thank you very much!