Author Topic: Tax Strategy for DINK 1SE 1W2  (Read 860 times)

teecup

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Tax Strategy for DINK 1SE 1W2
« on: September 15, 2017, 03:02:39 PM »
Other than the saving benefits, the tax rules simply draw my attention. I love finding ways to save and dislike leaving money on the table.
So here's our situation:

- DINK
- 1 W2 $60k
- 1 self employed ~$100k
- Mortgage $200k at 3.8%
- Car loan $16k at 1.49%
- No state income tax

Tax strategy each year:
- Max HSA $6,750.00
- tIRA $11,000 total
- Simple IRA $12,500 (W2 income) + $1800 company match (3%)
- Solo 401(k) $18,000 (self employment)
- Solo 401(k) company match max amount (~18% of profit)

We don't spend much, ~$40k/yr. The rest goes to taxable plan with Fidelity.

With the self employment income, does it make sense to hire the spouse for Sec 105 reimbursement only up to $12k/year?
Our health & dental insurance bills come up to roughly $6500. Even to cover the premiums only, we would be saving 15.3% ~$1k.

Any other strategies I'm missing?
Is switching to S-corp worth the extra work and fees?

I will read the mega backdoor roth IRA thread over the weekend and see if it's better choice than the taxable plan we currently have with Fidelity.

CareCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #1 on: September 15, 2017, 07:43:31 PM »
For the Section 105 reimbursement plan, the spouse would need to be legitimately employed, not just "employed."
https://www.tasconline.com/products/agriplan/section-105-plan-2/ seems to give a good summary, though I have not cross-checked it against IRS documentation.

Does the W-2 spouse have a 401k or equivalent at work?

An S Corp can be beneficial, if profit substantially exceeds the "reasonable compensation" for work being performed.

I'm not a medical reimbursement expert, but it would surprise me if you could have an HSA and a Section 105 plan. Hopefully someone with more experience will chime in.
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.

MMbergmann

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #2 on: September 15, 2017, 08:09:14 PM »
Does the W-2 spouse have a 401k or equivalent at work?

The SIMPLE is a former of 401k. They said they have one of those

CareCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #3 on: September 15, 2017, 08:24:27 PM »
Does the W-2 spouse have a 401k or equivalent at work?

The SIMPLE is a former of 401k. They said they have one of those
My bad - missed that part.
Today's a tax deadline - that's my excuse ;)
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.

DavidAnnArbor

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #4 on: September 16, 2017, 07:01:06 AM »
With self-employed income as high as $100,000 I think it does make sense to do an S-corp, pay yourself a salary, and avoid having to pay Social Security/Fica taxes on some of that business profit.
Moreover, if you're buying health insurance through the business that's another business expense deduction if you're an S-corp.

A lot of work though, and you have to pay Federal and State unemployment insurance and have a payroll created. This might be why a CPA would be useful here, but you should ultimately save money,.

teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #5 on: September 16, 2017, 10:22:32 AM »
For the Section 105 reimbursement plan, the spouse would need to be legitimately employed, not just "employed."
https://www.tasconline.com/products/agriplan/section-105-plan-2/ seems to give a good summary, though I have not cross-checked it against IRS documentation.

Does the W-2 spouse have a 401k or equivalent at work?

An S Corp can be beneficial, if profit substantially exceeds the "reasonable compensation" for work being performed.

I'm not a medical reimbursement expert, but it would surprise me if you could have an HSA and a Section 105 plan. Hopefully someone with more experience will chime in.

The spouse legitimately helps with the business. There's always paperwork, admin stuff, web maintenance to do.

From what I read from this site, the examples toward the bottom page seem to say that the premium can be covered through Sec 105 reimbursement. We won't be able to reimburse medical expenses below $2,600 to keep the it HDHP but as long as the premium can be fully expensed as business exp, it might be worth it?
Our spending mainly comes from dental work and I'm also looking to get braces and lasik (still convincing myself that it's not that scary!). Might have to split the treatment into 2 years to not go beyond $12k reimbursement limit but that seems to be a pretty big savings of SE tax alone.

If we're phased out for tIRA, should we put it towards Roth IRA?

As for the S-corp, how much of potential savings are we looking at?
I've been filing our taxes myself but with S-corp, we will need to pay someone to do our taxes until I gain more knowledge and feel more comfortable taking it over. I think S-corp filing will go roughly $1k at least? + payroll related taxes $1k (FUTA + state) on $60k salary + $420/yr to run payroll.

Assuming S-corp profit at $35k, the SE saving is $5,355.
Less ~$2.4k fees = $3k additional income. Is it worth the extra work?

teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #6 on: September 16, 2017, 10:24:56 AM »
With self-employed income as high as $100,000 I think it does make sense to do an S-corp, pay yourself a salary, and avoid having to pay Social Security/Fica taxes on some of that business profit.
Moreover, if you're buying health insurance through the business that's another business expense deduction if you're an S-corp.

A lot of work though, and you have to pay Federal and State unemployment insurance and have a payroll created. This might be why a CPA would be useful here, but you should ultimately save money,.

We buy the health insurance through the marketplace. It's not a group plan since the business is sole proprietorship.
Will we have to buy a more expensive plan if going with S-corp?

DavidAnnArbor

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #7 on: September 16, 2017, 03:10:46 PM »
With self-employed income as high as $100,000 I think it does make sense to do an S-corp, pay yourself a salary, and avoid having to pay Social Security/Fica taxes on some of that business profit.
Moreover, if you're buying health insurance through the business that's another business expense deduction if you're an S-corp.

A lot of work though, and you have to pay Federal and State unemployment insurance and have a payroll created. This might be why a CPA would be useful here, but you should ultimately save money,.

We buy the health insurance through the marketplace. It's not a group plan since the business is sole proprietorship.
Will we have to buy a more expensive plan if going with S-corp?

The business can buy whatever plan you want through the marketplace.

teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #8 on: September 18, 2017, 10:33:53 AM »
We buy the health insurance through the marketplace. It's not a group plan since the business is sole proprietorship.
Will we have to buy a more expensive plan if going with S-corp?

The business can buy whatever plan you want through the marketplace.

Got it, thank you.
I see you are also self employed. Do you have yours set up as S-corp?

teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #9 on: September 18, 2017, 10:37:14 AM »
I did some reading over the weekend on mega backdoor roth. Our plan is to reach FI in 5 years and work part time/side gig to bring in 20-40k/yr for living cost only.
Would it make sense to do mega backdoor given the set up + maintenance fee + paperwork?
Or should we just stick to taxable accounts where gain will be taxed at long term capital, which will be minimal anyway?

DavidAnnArbor

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #10 on: September 19, 2017, 05:03:04 PM »
I don't do an S-corp because my net business profit is only the $55,000 range.

Yes I think it makes sense for you to do the megabackdoor Roth. That's what I've decided to do. You could argue that if your income isn't so high you don't pay any capital gains taxes. And that when you retire you might have low income and not pay any capital gains taxes, that would justify having to pay the fee to find "plan documents" for a Solo 401k that includes the ability to do after tax contributions and in service non-hardship withdrawals.

Chances are if we are thinking about saving retirement at a relatively young age, we're probably going to have high required minimum distributions as well as social security. It's conceivable we might have to pay capital gains taxes. I would have to run the numbers on that, I'm not really sure.  If you're married filing joint, you can have a reasonably high income before capital gains taxes kick in.

Another reason to put assets in a roth over taxable is if you require health insurance subsidies on the federal exchange market - and you want to keep your AGI (adjusted gross income) number low enough to qualify,

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #11 on: September 20, 2017, 07:36:14 AM »
It probably would make sense to consider an S corp for the self-employed spouse.

You need to be careful about setting a reasonable compensation amount. But if you set that to, say, $53K-ish... you'll pay payroll taxes on that.

If you then have the S corp pay the HSA contribution as part of the shareholder-employee's wages, that money bumps the W2 box 1 amount but doesn't trigger more payroll taxes.

Your solo 401(k)'s 25% match is then roughly $15K because it's 25% of the $53K base and the $7-ish HSA...

Your total compensation package is the $53K plus the nearly $7K HSA plus the roughly $15K employer match.. so basically $75K.

That's probably good enough. Yet, you'll save that 15.3% FICA tax on roughly $47K... so that's about $7K of tax savings.

The problem with this approach, BTW, is that you'll have to do payroll or pay someone to do it... and you'll actually pay some new payroll taxes like FUTA or SUTA...and then you really shouldn't DIY the 1120S return. Too easy to goof that up. So you'll end up losing $1K to $2K of the gross tax savings to new payroll taxes and then the tax prep fees.

P.S. I don't think the HRA idea is a good one.
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DavidAnnArbor

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #12 on: September 20, 2017, 07:55:03 AM »
Very good SeattleCPA. Based on your numbers he could save $3-$4 K per year.

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #13 on: September 20, 2017, 01:47:57 PM »
Very good SeattleCPA. Based on your numbers he could save $3-$4 K per year.

:-)
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teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #14 on: September 20, 2017, 04:05:00 PM »
It probably would make sense to consider an S corp for the self-employed spouse.

You need to be careful about setting a reasonable compensation amount. But if you set that to, say, $53K-ish... you'll pay payroll taxes on that.

If you then have the S corp pay the HSA contribution as part of the shareholder-employee's wages, that money bumps the W2 box 1 amount but doesn't trigger more payroll taxes.

Your solo 401(k)'s 25% match is then roughly $15K because it's 25% of the $53K base and the $7-ish HSA...

Your total compensation package is the $53K plus the nearly $7K HSA plus the roughly $15K employer match.. so basically $75K.

That's probably good enough. Yet, you'll save that 15.3% FICA tax on roughly $47K... so that's about $7K of tax savings.

The problem with this approach, BTW, is that you'll have to do payroll or pay someone to do it... and you'll actually pay some new payroll taxes like FUTA or SUTA...and then you really shouldn't DIY the 1120S return. Too easy to goof that up. So you'll end up losing $1K to $2K of the gross tax savings to new payroll taxes and then the tax prep fees.

P.S. I don't think the HRA idea is a good one.


Would $53k be a reasonable amount of salary for $100k net profit? Is there a good rule of thumb on this?
The HSA contribution is currently taken out of the W2 income. Will having it paid by the S-corp generate more tax savings?

I can run payroll using 3rd party software. It'll cost roughly ~$500/yr for 1 employee.

Can I still form s-corp for 2016? Or will it be easier to start next year?

Can I ask why the HRA is not a good set up?
Health insurance is one of the major spending in our household and if we can legally expense it as business deduction, that would be great. Do you have any suggestions?

Sorry for the many questions. I get excited when talking numbers :)

teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #15 on: September 20, 2017, 04:19:06 PM »
I don't do an S-corp because my net business profit is only the $55,000 range.

Yes I think it makes sense for you to do the megabackdoor Roth. That's what I've decided to do. You could argue that if your income isn't so high you don't pay any capital gains taxes. And that when you retire you might have low income and not pay any capital gains taxes, that would justify having to pay the fee to find "plan documents" for a Solo 401k that includes the ability to do after tax contributions and in service non-hardship withdrawals.

Chances are if we are thinking about saving retirement at a relatively young age, we're probably going to have high required minimum distributions as well as social security. It's conceivable we might have to pay capital gains taxes. I would have to run the numbers on that, I'm not really sure.  If you're married filing joint, you can have a reasonably high income before capital gains taxes kick in.

Another reason to put assets in a roth over taxable is if you require health insurance subsidies on the federal exchange market - and you want to keep your AGI (adjusted gross income) number low enough to qualify,


Can you explain more about the high required minimum distributions you mentioned?
We are MFJ.

Good point on the insurance subsidies. How much does it cost you to set up mega backdoor roth and annual fee?

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #16 on: September 21, 2017, 07:04:17 AM »
Would $53k be a reasonable amount of salary for $100k net profit? Is there a good rule of thumb on this?

You shouldn't use a rule of thumb for breaking down the profits into salary and distributive share. But you might find this summary of (sort of) the average S corporation salaries by industry useful:

Average S corporation salary data based on IRS 1120S return


This blog post I did earlier this summer might help, too:

S corporation reasonable compensation



The HSA contribution is currently taken out of the W2 income. Will having it paid by the S-corp generate more tax savings?


I think so. Partly (or maybe wholely) because in an S corporation that HSA can probably be counted as W=2 Box 1 wages... and your W-2 Box 1 wages amount is what determines your employer pension match.


I can run payroll using 3rd party software. It'll cost roughly ~$500/yr for 1 employee.


That sounds right.


Can I still form s-corp for 2016? Or will it be easier to start next year?


For 2016? No, sorry. Several factors make this either impractical or impossible. One big issue: You needed an eligible entity (so probably an LLC) in existence on 1/1/2016 in order to have something to make the S election "for" on 1/1/2016. You're also now late filing that 1120S return (which means you're looking at at least $1200 of penalties). Further, you needed to have payroll back in 2016... needed to make payroll deposits and file returns, etc... you didn't so more penalties there.

BTW, if you have an eligible entity, you could still make the election for 2017 with a 1/1/2017 effective date... you'd just need to make sure you could get to a reasonable compensation amount by end of 2017.


Can I ask why the HRA is not a good set up? Health insurance is one of the major spending in our household and if we can legally expense it as business deduction, that would be great. Do you have any suggestions?

You can technically probably do an HRA if you're a one employee S corporation. But HRAs to me are often sort of a mess.

BTW, if you're thinking about an HRA simply to deduct the insurance, you should just have an S corp pay the health insurance.

Health insurance for an s corp shareholder-employee, if handled right, saves both income taxes and payroll taxes, bumps up your compensation, and means a higher "earnings" amount on which the employer pension match is calculated.

E.g., if you set your base to $48K but have $12K of insurance, box 1 on a W-2 from the S corp should show $60k. The employer 25% pension match in this case equals $15K. That puts your compensation to $75K which is probably high enough in  many situations. Especially if your tax returns are artfully prepared.

Note that in the above example, you're paying the FICA and SS taxes on the $48K and not on the $100K
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teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #17 on: September 22, 2017, 01:17:04 PM »
You shouldn't use a rule of thumb for breaking down the profits into salary and distributive share. But you might find this summary of (sort of) the average S corporation salaries by industry useful:

Average S corporation salary data based on IRS 1120S return


This blog post I did earlier this summer might help, too:

S corporation reasonable compensation

Thank you. Will read the articles over the weekend.


I think so. Partly (or maybe wholely) because in an S corporation that HSA can probably be counted as W=2 Box 1 wages... and your W-2 Box 1 wages amount is what determines your employer pension match.
Got it. So payroll tax saving will be the same since it's moving from W2 income to another W2 income. However, the S-corp increased W2 amount allows more employer pension match, which equals more SE savings.


For 2016? No, sorry. Several factors make this either impractical or impossible. One big issue: You needed an eligible entity (so probably an LLC) in existence on 1/1/2016 in order to have something to make the S election "for" on 1/1/2016. You're also now late filing that 1120S return (which means you're looking at at least $1200 of penalties). Further, you needed to have payroll back in 2016... needed to make payroll deposits and file returns, etc... you didn't so more penalties there.

BTW, if you have an eligible entity, you could still make the election for 2017 with a 1/1/2017 effective date... you'd just need to make sure you could get to a reasonable compensation amount by end of 2017.
Sorry, that was a typo. I meant to ask for 2017.
I'm a SP currently. Can I form an LLC now, and make the election with 1/1/17 effective date?
Can I pay a lump sum of the salary in Q4 to catch up the ~$53k?

You can technically probably do an HRA if you're a one employee S corporation. But HRAs to me are often sort of a mess.

BTW, if you're thinking about an HRA simply to deduct the insurance, you should just have an S corp pay the health insurance.

Health insurance for an s corp shareholder-employee, if handled right, saves both income taxes and payroll taxes, bumps up your compensation, and means a higher "earnings" amount on which the employer pension match is calculated.
Does this mean full business deduction for the insurance premium?

E.g., if you set your base to $48K but have $12K of insurance, box 1 on a W-2 from the S corp should show $60k. The employer 25% pension match in this case equals $15K. That puts your compensation to $75K which is probably high enough in  many situations. Especially if your tax returns are artfully prepared.

Note that in the above example, you're paying the FICA and SS taxes on the $48K and not on the $100K
This sounds great.

DavidAnnArbor

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #18 on: September 22, 2017, 07:20:33 PM »
I don't do an S-corp because my net business profit is only the $55,000 range.

Yes I think it makes sense for you to do the megabackdoor Roth. That's what I've decided to do. You could argue that if your income isn't so high you don't pay any capital gains taxes. And that when you retire you might have low income and not pay any capital gains taxes, that would justify having to pay the fee to find "plan documents" for a Solo 401k that includes the ability to do after tax contributions and in service non-hardship withdrawals.

Chances are if we are thinking about saving retirement at a relatively young age, we're probably going to have high required minimum distributions as well as social security. It's conceivable we might have to pay capital gains taxes. I would have to run the numbers on that, I'm not really sure.  If you're married filing joint, you can have a reasonably high income before capital gains taxes kick in.

Another reason to put assets in a roth over taxable is if you require health insurance subsidies on the federal exchange market - and you want to keep your AGI (adjusted gross income) number low enough to qualify,


Can you explain more about the high required minimum distributions you mentioned?
We are MFJ.

Good point on the insurance subsidies. How much does it cost you to set up mega backdoor roth and annual fee?

Required minimum distributions are so far down the road, and don't start til age 70.5 or when you finish with earned income, whichever comes later.

Discount solo 401k charged me $575 the first year and $100 each year thereafter. I'll keep using them as long as I have a minimum of $5,000 to put in a megabackdoor roth. This year I hope to get about $10,000 in through the megabackdoor roth.

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #19 on: September 23, 2017, 02:57:19 PM »
Got it. So payroll tax saving will be the same since it's moving from W2 income to another W2 income. However, the S-corp increased W2 amount allows more employer pension match, which equals more SE savings.

Exactly.

Sorry, that was a typo. I meant to ask for 2017.
I'm a SP currently. Can I form an LLC now, and make the election with 1/1/17 effective date?
Can I pay a lump sum of the salary in Q4 to catch up the ~$53k?

You can't make an S election with an effective date earlier than the entity formation. So really your next time to "get on the bus" is next year, on 1/1/2018.

Does this mean full business deduction for the insurance premium?

Yes, if you do it right. BTW the health insurance gets treated as Wages on 1120S and so a  corporate tax deduction. That means it's income that appears on your 1040... but then you should be able to deduct it there as a self-employed health insurance deduction.

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teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #20 on: September 24, 2017, 09:43:51 AM »
Got it. So payroll tax saving will be the same since it's moving from W2 income to another W2 income. However, the S-corp increased W2 amount allows more employer pension match, which equals more SE savings.
Exactly.

You can't make an S election with an effective date earlier than the entity formation. So really your next time to "get on the bus" is next year, on 1/1/2018.
Got it. Thank you for the clarification.

Does this mean full business deduction for the insurance premium?
Yes, if you do it right. BTW the health insurance gets treated as Wages on 1120S and so a  corporate tax deduction. That means it's income that appears on your 1040... but then you should be able to deduct it there as a self-employed health insurance deduction.
I'm still unclear about this. Can you please help explain more?
Doing it via S-corp will result in full business deduction, increase in 1140, but then deduct it again as above the line SE health ins deduction, so no SE tax will be paid for the premium, correct?
Will I have to add the premium amount to the S-corp W2 box 1?

Wouldn't doing it via spouse HRA yield more tax savings since the premium is SE and income tax free? (~$6.5k premium in our case)
And on top of it, unreimbursable expenses by the HSA can be reimbursed SE and income tax free? (~$5.5k per year to max the $12k limit).
That would be $975 SE tax saving on the premium + $2,200 tax saving on the expenses assuming (15%SE + 25% fed).

Are you opponent of doing this because it's an audit trigger?
Sorry for the many questions - as I mentioned, I like bouncing ideas and brainstorm to maximize tax savings. Hope I'm not boring you already :)

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #21 on: September 25, 2017, 07:58:21 AM »
« Last Edit: September 25, 2017, 08:00:55 AM by SeattleCPA »
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teecup

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #22 on: September 29, 2017, 11:46:30 AM »
This blog post explains how the rules work:

payroll accounting rules for S corporation shareholder-employees

This post might be useful too:

S corporations, health insurance, and Obamacare


Thank you for the link. You have lots of valuable information there and I have shared your blog to a friend of mine who's interested in s corp as well.

Based on what I've read, it makes sense to form s-corp next year and write off health insurance premium instead of HRA.
However, for 2017, since I'm going with SP, would it make sense to get on HRA plan to maximize tax savings?

SeattleCPA

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Re: Tax Strategy for DINK 1SE 1W2
« Reply #23 on: October 02, 2017, 08:23:19 AM »
This blog post explains how the rules work:

payroll accounting rules for S corporation shareholder-employees

This post might be useful too:

S corporations, health insurance, and Obamacare


Thank you for the link. You have lots of valuable information there and I have shared your blog to a friend of mine who's interested in s corp as well.

Based on what I've read, it makes sense to form s-corp next year and write off health insurance premium instead of HRA.
However, for 2017, since I'm going with SP, would it make sense to get on HRA plan to maximize tax savings?

For 2017, I would just take the SE health insurance deduction and the HSA deduction and not try to "upgrade" to the HRA in order to get some extra savings.

HRA is a problematic deduction for a sole proprietor. You'd need to make sure the compensation of your spouse was reasonable. Probably with an HRA that "beats" the SE health insurance deduction and the HSA, the compensation won't be reasonable... it'll be too much.
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