My Brain Hurts - Impact of S-Corp on Social Security & Retirement

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Messner8000
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My Brain Hurts - Impact of S-Corp on Social Security & Retirement

Post by Messner8000 »

Hi Everyone. For the first time this year we hired a CPA to do our taxes because my wife's small business (she is a sole proprietor) was getting too complicated for me. Our CPA has recommended filing taxes in the future as an S Corp. It seems clear to me that the tax savings will be greater than the additional costs for tax filing (CPA fees) and costs related to the S Corp (e.g., payroll software costs). What I'm having a hard time figuring out is the impact on social security and retirement accounts.

To pick a round number, let's say my wife's business has $100,000 in profit each year. Whereas if she files as an LLC she would pay 15.3% payroll tax on that amount, my understanding is that as an S Corp. she could (for example) designate $50,000 as payroll and $50,000 in profits and thus pay payroll tax on only half. This leads to my two questions:

(1) I think this would mean I wouldn't have to pay the payroll tax on chunk of the money. But this would also mean that our social security payment down the road would accordingly decrease. How do I possibly weigh the benefit of saving on taxes now with decreased social security payouts 20-25 years from now?

(2) Right now we can make a $22,500 employee contribution to her solo 401k, and a separate employer contribution of up to 25% of self-employment income. How would being an S. Corp. impact how much we could squirrel away for retirement? Right now our goal is to max out these retirement accounts each year, so I'm reluctant to do anything that would give us less tax advantaged space. But I don't know how to figure out if it would or not!

I greatly appreciate any thoughts!
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MP123
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Re: My Brain Hurts - Impact of S-Corp on Social Security & Retirement

Post by MP123 »

Messner8000 wrote: Tue Jun 06, 2023 1:55 pm (1) I think this would mean I wouldn't have to pay the payroll tax on chunk of the money. But this would also mean that our social security payment down the road would accordingly decrease. How do I possibly weigh the benefit of saving on taxes now with decreased social security payouts 20-25 years from now?
It's tough to make an exact calculation. But it's important to note that the formula for SS benefits has "bend points". These are where the benefit earned for a dollar of SS contribution "bends" downwards. For this year the first $1115/month of earnings returns 90% of the earnings. Then the formula bends and from $1115 up to $6721 only earns 32%. And above $6721 only gets 15%.

So somewhere around the top of the second bend point (roughly $80k/yr) is probably optimal for SS benefits, assuming it can be justified as reasonable compensation. Over the second bend point doesn't really give you much additional benefit. But, for example, a Dr making $800k probably can't reasonably pay themselves only $80k as salary. And taking only $1115/mo as salary, which would be a great 90% return on SS benefits, would be too low for most businesses.

Further, if a reasonable salary is above the SS wage base ($160,200 for 2023), then the S-Corp is really only saving you Medicare taxes, since you're already paying the maximum SS tax.
Messner8000 wrote: Tue Jun 06, 2023 1:55 pm (2) Right now we can make a $22,500 employee contribution to her solo 401k, and a separate employer contribution of up to 25% of self-employment income. How would being an S. Corp. impact how much we could squirrel away for retirement? Right now our goal is to max out these retirement accounts each year, so I'm reluctant to do anything that would give us less tax advantaged space. But I don't know how to figure out if it would or not!
Solo 401k contributions for an S-Corp are based on W-2 salary, not net business income. So in your scenario above you'd only have $50k as the basis for both the employee contribution and the 25% employer one, rather than the $100k you'd have as a sole proprietor.

Another thing to consider is the Sec 199a 20% QBI deduction. As a sole prop you'd get 20% of $100k, but as an S-Corp you'd only get 20% of $50k (the S-Corp's net income).

It can be helpful to run this through tax software and model different possibilities.
billaster
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Re: My Brain Hurts - Impact of S-Corp on Social Security & Retirement

Post by billaster »

Messner8000 wrote: Tue Jun 06, 2023 1:55 pm Hi Everyone. For the first time this year we hired a CPA to do our taxes because my wife's small business (she is a sole proprietor) was getting too complicated for me. Our CPA has recommended filing taxes in the future as an S Corp. It seems clear to me that the tax savings will be greater than the additional costs for tax filing (CPA fees) and costs related to the S Corp (e.g., payroll software costs).
Before you do this, make sure that you have taken account of the reduction in the Qualified Business Income deduction for the S-corp. While the S-corp may reduce your payroll tax, it also reduces your QBI deduction. Depending on your exact numbers either the Schedule C or the S-corp may have lower taxes.
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