Max individual 401(k) contribution for LLC taxed as S-corp?

[UM1234]

Client makes 250K as self-employed tech consultant. No employees. He wants to put away the maximum possible for retirement. I need to set up a retirement plan for him.

He is an LLC taxed as an S-corp. Pays himself 90K in W-2 compensation, and the rest is treated as S-corp dividends not subject to payroll tax.

1. My understanding is that he'll be able to contribute more to an individual 401(k) than a SEP, because he only has 90K W-2 compensation, and a SEP contribution would be calculated just based on the 90K. Am I correct to think individual 401(k) will allow him to contribute more, or am I missing something?

2. Assuming we do individual 401(k), he will do $17,500 in 2013 as pre-tax 401(k) deferrals. I am trying to get an idea of how much profit sharing he'll be able to put in. This leads to questions 2a and 2b below.

2a. For an owner, is the max profit sharing contribution 20% or 25% of net self-employment income?

2b. With an LLC taxed as an S-corp, what number would I use for net self-employment income? 250K total earnings, 160K S-corp profit (250K earnings - 90K W-2 comp), or another number?

Thank you in advance for any thoughts you can provide.

[K2retire]

S Corp dividends are NOT self employment income for plan purposes. His profit sharing contribution will be limited to 25% of his W-2 wages.

[shERPA]

Tell him to bump is W-2 up to $134K and he can do the 415 maximum 401(k)/PS of $51,000.

[John Feldt ERPA CPC QPA]

To get the maximuim, shERPA is right:

25% of $134,000 = $33,500 (maximum deductible employer contribution is 25% of eligible compensation). This amount is not subject to FICA tax.

plus a $17,500 deferral. This is subject to FICA. This amount is not part of the 25% employer deductible contribution limit. The deferral is deducted by the employer as employee wages (regardless of whether the employee chose to defer as Roth or pre-tax).

Total $51,000

If the employee was born on 12/31/1963 or earlier, they can also defer an additional $5,500 in 2013. The $5,500 is treated like a deferral above.

Total $56,500

Assumes no other deferrals made that are subject to the 402(g) limitation, since the 402(g) limit is an overall individual limit, not just a single plan limit.

[UM1234]

Thank you very much to all who posted. It's extremely helpful.

Thoughts on the below are welcome. Thank you!

Re: increasing W-2 comp to 134K, it seems to me that the income tax savings of going from 40K to 51K retirement contribution would be almost exactly offset by the increased SE tax. $4,319.70 income tax savings vs. $4,214.80 more SE tax. Calculations below.

Even if the tax is a wash, I see two other benefits to bumping up W-2 to 134K. But practically speaking, I'm trying to figure out if these benefits are enough for me to recommend bumping up the W-2.

Benefit 1. Client gets $11,000 more into a tax-deferred account where it can compound and hopefully be withdrawn in a lower income tax bracket in retirement.

Benefit 2. To the extent one believes Social Security will be around for the long haul, there is some benefit to reaching the SS wage base of $113,700, because you need 35 years of max SS earnings to get the max possible SS benefit. But Client is ~ 35 yrs old so I tend not to put a lot of stock in SS for him.

Calculations:

Client's marginal income tax rate is 33% federal + 6.27% state = 39.27%.

$11,000 additional retirement contribution x 39.27% = $4,319.70 income tax savings.

$23,700 more subject to full SE tax @ 15.3% = $3,626.10.
($90,000 + $23,700 = 2013 Social Security wage base of $113,700.)

$20,300 subject to Medicare SE tax @ 2.9% = $588.70.
($113,700 + $20,300 = $134,000 total W-2 comp.)

$3,626.10 + $588.70 = $4,214.80 total increase in SE tax.

[UM1234]

Other questions:

1. I know in some cases that part of calculating the max retirement contribution involves subtracting 1/2 the self-employment tax. In the situation I've described, is the max just a flat 25% of 90K (or 134K if W-2 is increased)? Or are there additional steps to the calculation?

2. Also, I believe that for at least some self-employed people, the max ends up being 20% rather than 25%. In the situation I've described, why is it 25% and not 20%?

Thank you again so much.

[Bird]

The 1/2 self-employment tax adjustment applies when a taxpayer is "self-employed" - that is, taxed as a sole proprietor or partner. They pay both ends of the SE tax and get to deduct half, just like a corporation gets to deduct its (employer) share of the SE tax. In your case, the owner is getting a W-2, so there's no SE tax adjustment to be made, and you are simply dealing with 25% of W-2 income.

As far as the analysis of whether he should bump his income, it is probably 6 of one, a half dozen of the other. Of course, in theory the decision on how much to take as W-2 income should have nothing to do with how much he can contribute, it should be based on what is reasonable compensation.