Self Employed Deduction of Contributions

[austin3515]

http://hr.cch.com/news/pension/042312a.asp

Take a look at this, from today's BL newsletter. This has always bothered me because it puts SE individuals at a disadvantage from corporations. IF a corporation does a PS contribution for the owner, the PS contribution is not subject to SE Tax. But because the SE's contributions are deducted on page 1 of 1040, they are still included in SE Income.

Am I missing something or do others agree that SE Individuals are paying more in payroll taxes (assuming two otherwise identical businesses)?

[ETA Consulting LLC]

This is correct. The profit sharing contributions to self-employed individuals are based on Income that has already been taxed for FICA. Keep in mind, however, that the Self-Employed has an advantage once their overall pay gets above the taxable wage base (as their overall payroll tax is reduced to 2.9%; which is 1.45% times 2). If they are taxed as a corporation, the employee portion would be reduced to 1.45% while the employer portion will remain at 7.65%. This only comes into play when compensation reaches the taxable wage base.

It helps to know every attribute when choosing how the entity is taxes. There are "gives and takes" for each alternative.

Good Luck!

[austin3515]

Keep in mind, however, that the Self-Employed has an advantage once their overall pay gets above the taxable wage base (as their overall payroll tax is reduced to 2.9%; which is 1.45% times 2). If they are taxed as a corporation, the employee portion would be reduced to 1.45% while the employer portion will remain at 7.65%. This only comes into play when compensation reaches the taxable wage base.

I'm intrigued... Can you please provide an example? I'm not sure I'm following how they're better off.

[ETA Consulting LLC]

I'm intrigued... Can you please provide an example? I'm not sure I'm following how they're better off.

It's not necessarily "better off", but an issue of "may not be as bad". We know the regardless of what the "Employee" pays, the "Employer" portion of FICA is 7.65% until Compensation reaches $110,100. Then, it's reduced to 1.45%. Let's supposes a business is unincorporated where the owner actually receives $110,100 in W-2 from another unrelated employer. When he calculates his taxes for his business, his over FICA will begin at 2.9% (that's 1.45% to the Employee and 1.45% to the Employer). This takes advantage of the total FICA paid on W-2 from the unrelated employer.

On the Contrary, let's supposes that the owner's business is taxed as an S-Corp. In this event, his "Employer" portion of the FICA will begin at 7.65% until the W-2 taken from his own business reaches $110,100. The "Employer" does not get to the reduced rate by leveraging Compensation received while working for another company.

In the end, it "may" not amount to much, but a nice piece of information to know.

Good Luck!

[mbozek]

http://hr.cch.com/news/pension/042312a.asp

Take a look at this, from today's BL newsletter. This has always bothered me because it puts SE individuals at a disadvantage from corporations. IF a corporation does a PS contribution for the owner, the PS contribution is not subject to SE Tax. But because the SE's contributions are deducted on page 1 of 1040, they are still included in SE Income.

Am I missing something or do others agree that SE Individuals are paying more in payroll taxes (assuming two otherwise identical businesses)?

There are tradeoffs in different types of business entities which provide different benefits. While the SE person pays SS taxes on pension contributions as wages subject to SS tax, the SE owner will recieve additional SS benefits if the total SE income does not exceed the FICA max of 110k.

For example, if the owner of an S corp that has earnings of 100k, makes a 25% contribution to a PS plan of 20k, the 20k reduces the W-2 wages paid to the owner to 80k.

A SE owner with earnings of 100k would have net earnings of $92.35k for pensions and a pension contribution of $18,470 (25% of $73,880) for which the owner will pay $2290 in additional SECA 6.2% tax.

However the SE owner will have additional SS wages which will increase his SS benefit. Of course whether this is good depends on your view of whether SS benefits will be reduced in the future.

I thought that congress waived the SECA tax on SE employees contributons to their pension plans in 2010.

[austin3515]

So if I may summarize, in all cases, SE employees pay more in FICA taxes, correct? I say "all cases" becaise there is no cap on the medicare tax.

Even in the "two jobs" example, the owner would get a refund of the overpayment of SS Taxes.

[mbozek]

So if I may summarize, in all cases, SE employees pay more in FICA taxes, correct? I say "all cases" because there is no cap on the medicare tax.

Even in the "two jobs" example, the owner would get a refund of the overpayment of SS Taxes.

To the extent that the employer as opposed to the employee owner makes contributions to the plan, the answer is yes.

For example, if an S corp with 250k of earnings makes a 50k contribution to the owner's account in a PS plan there will be a savings of $1450

(.029% x 50k) because no medicare tax is paid. But there is no savings to the extent the owner contributes to the plan.

If the S corp has 100k in earnings and the owner contributes 22k by salary reduction and 20k in employer contributions the savings diminshes to $580 (.029% of 20k).

There are hidden costs in the S corp which will diminish the savings such as paying an accountant to prepare the S Corp tax returns.