Single Person 401k and Compensation Definition

[Guest amm19]

An Owner Only Business has become incorporated and wants to establish a qualified plan. The way the CPA explained this to me, the owner has become incorporated to help with social security taxation and limits the salary and dividends (draws/distributions) that he receives so as to not exceed the taxable wage base. In doing so, the owner wants to limit compensation to the taxable wage base, but will only have a W-2 salary of roughly $40,000 and the remaining $40,000 will come in a dividend as reported on form K-1. Is there a definition of compensation that will capture the W-2 and K-1 dividend? Possiblty 3401(a)? Or is there no way to report the dividend as compensation for plan purposes?

Thanks!

[E as in ERISA]

"You can't have your cake and eat it too!" If you don't want it treated as compensation for payroll tax purposes, it generally won't count as compensation for plan purposes!

[actuarysmith]

Katherine is correct. K1 income is not considered earned income for retirement plan computation purposes.

Amm19- why would the CPA want to keep the income "below the Social Security Wage Base"? Once you exceed that number, your payroll taxes decrease.

I understand wanting to keep income low, but the reference to the Wage Base makes no sense to me.....................

[Guest amm19]

I'm by no means a CPA, but as I recall he wanted to reduce the amount of social security taxes?!?! or some type of taxation along those lines. In any case, they will limit the income to the TWB whether it be purely salary or a combo of salary and dividends. I did not follow completely outside of the pension plan, but this came from a reputable CPA (if there is such a thing anymore).

Thanks!

[MGB]

But, has the CPA considered the effect of a loss in Social Security benefits due to this change? The public perception that saving on FICA is always the best thing to do is not always correct, depending on the individual's circumstances. In particular, if the self-employed person had many years of zero or near-zero earnings (or negative), then later building up their compensation history for SS purposes can result in a huge payoff. Similarly, a young person with a family that is subject to high risks of mortality and/or disability will get a huge payback in SS benefits compared to the FICA paid if one of these events occur (it can actually be cheaper than buying private insurance). Again, the universal "truism" that reducing FICA is always the appropriate thing to do is simply hogwash. I have been fighting for 20 years against communication "experts" that always promote FSAs as being a great tool to reduce FICA without ever explaining that the person may not actually want to do this.

[Mary Kay Foss]

At a seminar that I attended the speaker said that if someone consistenly earned one-half of the Social Security wage base they would receive approximately 70% of the maximum social security benefit.

Many of my clients have no faith in the social security system being around to pay them a benefit throughout retirement and are always looking for ways to reduce the social security burden. In addition, clients who are receiving social security are very reluctant to pay more money into the system especially if it cannot increase their benefits.

In my experience only individuals who have not worked consistently or are short on the number of coverage quarters are interested in paying social security tax.

It is interesting that they want to maximize contributions to a retirement plan at the same time that they're avoiding social security tax. You really can't have your cake and eat it too.