Small Business (S-Corp) and Taxes

[l2jperry]

Hey all,

I'm sure this has been covered on here before, but I was unable to find anything regarding it. I did checkout the sticker topics at the top, but unfortunately they didn't really pertain to business and taxes. Last year was my first year in business, and it turned out to be a great year. Unfortunately, all of this is still so new to me that the only thing I was able to take advantage of was maxing out a traditional IRA, and therefore paid A LOT in taxes.

I plan on making, after business deductions, somewhere between 180k-230k. As of now this is what I have set up to defer taxes and save for FIRE:

Traditional IRA - $5,500 maxed out
Simple IRA - $12,500 (plus a 3% match.) I am an S-Corp and as of now my pay is 25K (accountant thinks we should go a little higher this year) but that gives an extra $750.00 bringing the total to $13,250.
HSA - I am 25 so I am currently on my Mom's Health Care plan at her work, I pay her $110.00 a month for it and just assumed that was going to be cheaper than going out on my own plan. I need to start looking into this as I will need my own coverage in another 7 months or so, and at that point I will also contribute to an HSA, but that doesn't do me much good for 2016.

Those are the only 2 things I have, is there anything else I could do, could I also establish a 401K and put more money into that? Is there any other type retirement accounts I could take advantage of being a small business S-Corp?

Thanks as always for all the wise information given on this forum!

[dandarc]

You're being very aggressive on the "reduce FICA" front, but switching from a SIMPLE to a soloK (reads like you don't have employees - if you do have employees, things are more complicated as your retirement plan has to be fair) would allow you to defer some more, even at that very low salary.  You'll be able to do 18K + 25% of salary into a soloK.

If you up your salary, you'll be able to defer more income in the employer match in the soloK, but you'll be increasing your FICA tax.  At your low salary, there is a long way to go to the social security maximum, so you'll likely come out behind on current-year taxes.  So for the owner-employee who is inclined to defer, these things off-set to an extent.  Also if you take more salary and pay more FICA, you get higher social security benefits, but the value of that would depend on your overall situation.

[bobechs]

Following

[l2jperry]

Thank-you for the reply dandarc.

I do have employees (2 of them not counting myself) and my business is one that could grow where I would need more employees. It is because of that that I thought the SIMPLE was the best way for me to go. Knowing that, is there is something else I should be taking advantage of? Is it possible to also have a Simple and then start a 401K to up my contribution to 18k total with the Simple (plus the 5-6k or so in a 401k)?

I am only 25 at a net worth of roughly 330k, the plan is to get to 600k and then travel around the states working at various places (Kayak Tour Guide in the Grand Canyon, White Water Rafting guide, etc. etc.) So I feel that paying more money in FICA taxes is not in my personal situation the best answer (obviously I will pay what my accountant feels is necessary as far as the law goes, but I don't want to increase my wage strictly to put away a higher match.)

Thanks again!

[jwright]

Even with employees; you should still do the 401K and defer 18K that way.

$25K salary on $200K profit would be a red flag in my view, and as a CPA I would advise a more reasonable salary.

[l2jperry]

Thank-you for the response JW.

So by doing a 401K does that mean I can't also do the SIMPLE IRA with a Traditional IRA? And since the Simple and the Traditional are cheaper to implement, couldn't I put away a little more by doing both of those instead of the 401K?

The business I am in is selling T-Shirts, and I actually am never really there... about half the income is passive, another company handles all the printing and shipping, and the other half is done by my employees in my own shop. I live in a very rural area where income is low, I guess you could classify me as a graphic designer. What do you think a more reasonable Salary would be under that circumstance?

Appreciate everyone's help! I am completely new to all of this tax stuff.

[dandarc]

You almost certainly cannot deduct a traditional IRA at your income - so if you're using one, it should simply be a conduit for a backdoor Roth IRA.  There are some gotchas with that strategy, so be sure and read up before jumping in there.

Your business cannot have a SIMPLE IRA and a 401K at the same time.  IRS website for SIMPLEs is clear on this "Employer cannot have any other retirement plan" https://www.irs.gov/Retirement-Plans/Choosing-a-Retirement-Plan-SIMPLE-IRA-Plan

So for 2016 you're in a SIMPLE.  For 2017 you can switch to a 401K if you take care of the paperwork by year end of 2016 (I think).  There is such a thing as a SIMPLE 401K, but it doesn't have the higher limit, so no idea why you'd choose that route.

[jwright]

Not knowing the fully story but...

You can't deduct the traditional IRA through the business.  So it is business income and then you can potentially personally deduct the $5,500 contribution.  If you have $200K in income, you are making too much to take the deduction though.

If you make the 18,000 401K deferral, the business deducts all of that money as a shareholder wage expense and you don't take it into income, so you are getting the full $18K deduction.  You will be on the hook for eventually covering employees under this plan, but it is after 3 years of service, there's a safe harbor for 3% of their salary, your business gets a deduction when you pay it, and it will increase morale and loyalty in employees.

As to reasonable comp, you have a good arguement that the revenues generated by your business are not a result of your personal service.  The rule of thumb is that you must pay yourself what it would cost to replace you.  Could you replace yourself with a full time employee paid $10/hour?  Or a half time employee paid $20/hour?  I've also heard that there is a red flag if distributions are significantly greater than the salary.  But just because it gets flagged doesn't mean it is wrong.  It just means you will have to explain yourself.  With a solid fact pattern, the IRS will agree with you.

[l2jperry]

Interesting information you guys, thank-you again for your help.

So, am I correct in assuming I have 3 options really...

1.) Only have a traditional IRA and deduct $5,500
2.) Only have a Simple IRA and Deduct $12,500 plus 3% match plus employees.
3.) Have a 401K and deduct $18,000 plus employees

On a side note, an HSA can be combined with any of these correct?

I am open to anything, is there anything I can do to twist things around to be able to put more money away? Say... get rid of employees and have a solo 401k?

Why do they have to make this stuff so confusing? :)

[robartsd]

The Traditional (or Roth) IRA is a personal account, you can do it on your personal (earned) income regardless of what you decide your business does. It has no impact on your business. The decision on what retirement plans your business sponsors for employees is separate. A HSA is related to a high deductable health insurance plan (which could be an employee benefit or could be obtained personally) it is not related to the retirement accounts you have. Retirement plans sponsored by the business must be fair to all employees - so you have to weigh the ability for the business to contribute to your retirement against the oblication of the business to contribute to other employee's retirement (loss of profit to you as business owner).

[slowsynapse]

If your profitability is growing and you are looking at different types of retirement accounts for the company, I would at least explore a Simplified Employee Pension (SEP).  There are ways to get much larger contributions into a tax deferred account.  It may not work for your specific situation but it is nice to know all of the options.

https://www.irs.gov/Retirement-Plans/Plan-Sponsor/Simplified-Employee-Pension-Plan-%28SEP%29

[jwright]

Interesting information you guys, thank-you again for your help.

So, am I correct in assuming I have 3 options really...

1.) Only have a traditional IRA and deduct $5,500
2.) Only have a Simple IRA and Deduct $12,500 plus 3% match plus employees.
3.) Have a 401K and deduct $18,000 plus employees

On a side note, an HSA can be combined with any of these correct?

I am open to anything, is there anything I can do to twist things around to be able to put more money away? Say... get rid of employees and have a solo 401k?

Why do they have to make this stuff so confusing? :)

3.  With the 401K, you can also have a profit sharing plan that contributes 25% of compensation.  You can combine the two.

[l2jperry]

It sounds like the way to sock the most money away is with a 401K, but everything I have come across is pretty pricey. With the Simple it's free to setup and no administration cost through vanguard. There is only a $25.00 fee per fund you put your money in.

I have already put away $5,500 into a Traditional this year, and wish that I hadn't!

[BlueLesPaul]

If you make the 18,000 401K deferral, the business deducts all of that money as a shareholder wage expense and you don't take it into income, so you are getting the full $18K deduction.  You will be on the hook for eventually covering employees under this plan, but it is after 3 years of service, there's a safe harbor for 3% of their salary, your business gets a deduction when you pay it, and it will increase morale and loyalty in employees.

So just for my own sake, this would only be the case if you incorporate.  If you are a Sole Proprietor, Partnership or LLC taxes as those two, you would have to pay SE tax on your own retirement contributions, correct?  Do you need to pay SE on 'Employer' contributions to your own account?

I agree that the salary seems pretty low, but a lot of it will depend on place of business and comparable salaries for your type of business.  I also agree that 401(k)/HSA and looking into a backdoor Roth via a non-deductible tIRA looks like your best option since the Roth is out.

[With This Herring]

You need to talk to your accountant and take his/her advice about what your salary should be.  If your business is making a profit of "somewhere between 180k-230k" as an S Corp, and your salary as the only owner is set at 25K, you can run afoul of the IRS saying that you are abusing the S Corp form as a way to avoid payroll taxes.  There is a safe harbor minimum salary threshold ($100K-ish?) that will keep you in the clear, so you need to ask your accountant about that.

This is the best time to go ask your accountant about advice on salary and retirement plans, as the rush of Tax Season is over and most people haven't started looking at summer travel yet.  It also leaves you with plenty of time to bump up your salary for the year and to get paperwork set up for any retirement plan changes.