S-Corp New Comparability 401k plan

We are looking at a prospect, small law firm, one 100% owner, his wife and about 6 staff.  Entity is an S-Corp.  It's been a while since i've dealt with an S-Corp, but back then i remember the S-Corp owner being paid by W-2.  I remember, I hope correctly, that they had be paid by W-2 for plan purposes.  This S-Corp has K-1 income.  Can that be used for similar to partnership calc for retirement plan contribution purposes (without SE tax)?   Or must it be be W-2 comp?  Thanks in advance for all replies.

W-2.

8 hours ago, dmb said:

We are looking at a prospect, small law firm, one 100% owner, his wife and about 6 staff.  Entity is an S-Corp.  It's been a while since i've dealt with an S-Corp, but back then i remember the S-Corp owner being paid by W-2.  I remember, I hope correctly, that they had be paid by W-2 for plan purposes.  This S-Corp has K-1 income.  Can that be used for similar to partnership calc for retirement plan contribution purposes (without SE tax)?   Or must it be be W-2 comp?  Thanks in advance for all replies.

ABSOLUTELY NOT (can the K-1 be used); only W-2 income from the S corp counts; the S dividend is just that, a dividend and not earned income.  In partnerships, the net earnings from self-employment (and S shareholder is NOT self employed) comes from the K-1 information (and a few other items that need to be asked).

Agree with the others.  I have had a long standing battle with accountants who advise business owners to set W-2 artificially low to save  FICA taxes without explaining the limits that is putting on their deferral opportunities into tax qualified plans.

Unless you client needs to reduce his income to maximize his QBI deduction, consider that jacking up W-2 at the expense of K-1 for Plan contribution purposes may be reducing a 20% income exclusion on K-1 for tax deferral in respect of W-2. At least until 2026 under present law.

I am not a CPA but from reading posts about the QBI deduction I am under the impression that there is some kind of reasonable compensation standard that should be applied when determining the amount of the W-2 vs pass-thru for an S-Corp owner. It’s not simply what works best - theoretically. True? 

If the S-Corp owner's taxable income is >= the W-2 wage limitation phase-in range (MFJ $321,400 - $421,400). Then the qualified business income is limited to 50% of the W-2 wages of all employees. This is far more restrictive of a single employee S-Corp than these circumstances with the owner/spouse and six (6) employees.

This is a separate issue than the IRS' increasing focus on reasonable compensation of S-Corp 2% shareholder-employees. I would only expect increased scrutiny when not only does the 2% shareholder-employee save FICA taxes on paying unreasonably low compensation, but they increase their QBI and possible deduction.