r2i forum

Would appreciate any inputs on the below:

I have recently registered a company (S corp) and want to put away the max I can in a 401K plan. The max limit is 15.5K + 25% of the salary as the employer match with a max contribution of 45K.

Here's the confusion:
If I bump my salary up to be able to contribute the max towards the 401K, i.e. pay myself 120K to reach the 30K employer portion in order to reach the max allowed of 45K in the 401K, I end up paying more FICA taxes (15.3%).

Does it make sense to pay the 15.3% on the extra salary I need to pay myself in order to be able to put aside the max in the 401K. If I don't put money in the 401K, I will be taxed @ 35% to 40% on that amount.

HELP!!
India_Calling

IRS guidelines say that you need to pay yourself reasonable salary for the kind of work/service you are doing. My accountant says that you need to pay yourself at least 50-60% of revenue as salary to avoid inquiry from IRS. This is for S-corp. You may want to pay higher salary yourself if you want to contribute max to 401(k) plan and take advantage of tax-deferred growth.

Thanks for the reply, however is it worthwhile to pay the extra FICA on the huge salary when I can get by paying myself a little lower? I understand in order to max the 401K, I have no option, but my question is; is it worthwhile to do so or am I being shortsighted...

OP:

FreeSpirit makes a good point. Beyond that:

You are subject to 3 limits:

15,500 (not 15K) limit for employee contribution for 2007
45,000 limit for total contribution - employee + employer - for 2007
25% of compensation limit for employer contribution.

So employer contribution can be 29.5K and employee contribution 15.5K to reach 45K max total limit.

For 29.5K employer contribution, compensation needs to 4 * 29.5K = 118K (not 120K).

Now regarding FICA on the 118K:

For 2007, the SS portion of 6.2% + 6.2% has a cap at 97,500 - beyond that it is only the medicare portion at 1.45% + 1.45% that has no cap.

Run the numbers with the above inputs and see whether increasing compensation to take advantage of 401(k) contribution makes sense.

Bobus,
Firstly ....Thanks

I had all this information and was still confused if paying social to max the 401K made sense. I mean the 401K I can still pay the 10% and get back what I put in. The social really seems like a tax that may or may not see the light of day.

I am surprised to see so few answers to my question. I would assume there are a lot of folks out there who have dealt with this question.

Anybody???

Thanks

India Calling:

General questions tend to get general responses.

First, it will help if you post info on what exactly is feasible in your situation, given the point that FreeSpirit made - how much freedom do you really have, given that IRS requires fair compensation and not some arbitrary divving up of surplus between compensation and dividends.

Second, the question about how much sense does contribution at the cost of FICA taxes make, depends on your tax rate (you have provided some info), and also your GC or USC status, and your 401(k) exit plan.

Hypothetical what if scenario questions may not excite respondents if it seems like a fishing expedition. The person seeking info can come bare with all info - instead of selectively doling out or rationing info that he deems relevant - if he knows what is relevant why is he asking?

Point well taken Bobus. Let me elaborate....

I am a GC holder eligible for citizenship (US) next year. I plan on R2I in the next year or by 2009. I would have completed 10 years in the US and would have earned the 40 credits from a social security perspective, so should be eligible to receive the SS checks when and if I reach that age.

As far as co details... I should be able to put aside the 45K towards the 401K if I want to. My tax rate is close to 40%. If I pay the 15.3% FICA and put aside that much more into the 401K, it seems to make sense. I'm not a 100% sure if I'm thinking this through and that's why I need inputs from folks here. Like I said, I'd assumed other folks would have gone through such decision making as well.

Best Regards.

India Calling:

Lets put aside 401(k) contribution for the moment. Given Free Spririt's point, what is the degree of freedom you have? What would be a reasonable compensation that would not raise IRS eyebrows in your case? If it is 97.5K or higher, then we are dealing with peanuts here.

Reasonable from what I heard is very subjective. Some CPA's have told me that I can get away with paying myself 20K a year.

The facts are however that I bill @ 110$/ hr for myself and all that and only that is the co's revenue.

So, if I pay the 120K a year as salary to myself, then I can put aside a lot more however end up paying FICA.
If I pay 20K a year as salary, the corporation pays taxes on the remainder as S corp taxes. (No FICA).

So I guess the real question is... avoid FICA and put away lesser in the 401K or pay FICA and put away more?

HELP!!

India_calling

http://www.nysscpa.org/cpajournal/old/13928348.htm (1992 article)

http://www.nysscpa.org/cpajournal/2006/506/essentials/p46.htm (2006 article)

http://www.smbiz.com/sbw1019.html#s2 (another article)

If I were you I would probe the adequate compensation issue further first - the probe may render the issue you are grappling with moot.

Some CPA's have told me that I can get away with paying myself 20K a year.

Did you pay a fee or was it casual party talk advice? Will they take the fee from you and pay penalties and interest that are imposed in the event of an audit?

Extract from the third link above (Less than 5 minutes of Googling got me to the links, and I have no monetary interest in the issue)


How much salary should you take? That depends on the circumstances. If you do significant work for the corporation or are an officer, and report no salary, you're asking for trouble. In fact, not reporting an amount on the line 'Compensation of officers' is probably a tipoff to the IRS. They figure that every corporation has a officer that does some work for the corporation. It may be a small amount, but there should be something on that line.

Ok, you're resigned to reporting something. Now how much? That depends on the facts and circumstances. You might truly be a passive investor, have other interests, or spend only a minimal amount of time working for the corporation. If you keep a log of your hours, and you can put a dollar amount on them, you can compute the amount. For example, you have other interests so you only spend about 1,000 hours a year working in the business. The business is small and not very profitable. You could hire someone to do your job for $25 an hour. A salary in the area of $25,000 would be reasonable. Even a slightly lower amount would probably not be challenged.
On the other hand, you're the brains and reputation behind a four-man consulting business with profits of $350,000 a year and you take a $20,000 salary. Expect a problem from the IRS.

Justification for a low salary. Here are some factors that might justify a low salary:

The business is losing money or only modestly profitable.

The business is in start-up mode and needs to reinvest the cash.

The business is very capital intensive and you've invested a large amount of equity capital. You're entitled to a return on the money.

Your salary is in line with what other employees in the same business and industry are getting for the same work and skill level.