Small Business Owner: W2 Bonus or Owner Draw?

[5Years2Freedom]

Hey there,
I run a small business with my wife as the only other employee. We have a Solo 401(k) for which we hope to max out the employer contribution (in addition to personal contributions). Our salaries cover all of our expenses and we no major expenses planned. That's all background.

As the business owner, I'm in a position that if I take extra withdrawals above W2 salary, I can take them as W2 Bonus or as Owner Draws. In the past, I've just defaulted to owner draws, but am not certain that this is the optimal choice.

Owner Draws have two obvious advantages in that (1) there's no FICA tax on them and (2) the 20% Qualified Business Income deduction.

A W2 Bonus has the advantage of increasing the Solo 401(k) Employer Contribution that can be made.

I'm guessing that since nearly everything I know and have read online, such as small business owners always aim to maximize draws over W2 salary (to the point of folks pushing the too low salary line), suggests that this is actually a no brainer in the end. That said, it'd be great to rest easy knowing I'm optimizing everything I can!

Thanks for any info and advice!
5Y2F

[feelingroovy]

I'm in a similar situation, though I have employees, so the 401k employer contribution option is less optimal for me.

In your situation I would still take it as a draw. Unless maybe you're in a super high bracket in a state with high income tax rates.

401k is great but you're still deferring tax, not eliminating. With the draw you are truly eliminating that payroll tax.

[HBFIRE]

I'd talk to your CPA.  We faced the same dilemma as you.  We also are a small business (one partner, and our wives) but we are also very profitable with relatively large revenues.  It turned out our best option was a self defined benefit plan (W2'd) -- can put away much much more than a solo 401K.  You might look into it (there are lots of rules on them, and its definitely more complex, but the amount you can put away is superb).  In any case, it's worth setting up a meeting with your CPA and running the numbers.  We are an LLC taxed as an S Corp.