I’m a design professional running my business as an S-Corp (just me, no employees). This is my third year with a solo 401k. The past couple of years were great and I maxed out both employee and employer contributions.
But this year was rough, so I’ve only got $31k to contribute. I can’t find much info on how to split the contributions between employee and employer, other than articles about maxing everything out.
My total receipts are around $128K, and my 2024 payroll to myself is about $50K. I’m working through year-end expenses, but it looks like my business profit will be pretty low, if not negative.
Personal details: Married, filing jointly. My husband’s income is under $30K (he got laid off twice this year). I’ve got around $7K in long-term capital gains (used to max out Roth IRA $7K).
For this year, the employee limit is $23K and the employer contribution limit is 25% of my W2 salary, which is around $12.5K. Should I max out employee contributions first to stay safe in the 12% tax bracket, or go with employer contributions to avoid higher payroll taxes on contributions? Are there any other things I should think about?
It’s usually better to contribute to the employee part first. That’s because employer contributions reduce your net profit, and your net profit counts for the 20% QBI deduction, which means only 80% of it is taxed. But your salary is taxed in full.
The problem is, if you’ve already paid yourself, it’s hard to go back and adjust it.
@Tavi
Thanks for the quick reply! This year dropped off so much that my net profit might be almost nothing, but I’ll double-check my books. This is helpful for next year too. I thought the QBI deduction was gone, but I just checked with the IRS. Thanks again!
Employee deferrals are subject to FICA taxes, so it might be better to max out employer contributions. Employee vs employer doesn’t really matter much for income tax brackets, except when it comes to FICA taxes and the QBI deduction.
Ren said: @Tavi
I assumed the $50K was already paid and any 401(k) would be on top of that. If that’s not the case, then this makes sense.
Exactly. If you have to pay extra FICA, it might make sense to focus on employer contributions, at least for now. (Extra W-2 income could also boost your future SS retirement benefits, depending on your situation.)
Ren said: @Tavi
I assumed the $50K was already paid and any 401(k) would be on top of that. If that’s not the case, then this makes sense.
I’ve already processed the $50K throughout the year and paid all taxes on it. The $35K was just sitting in a high-yield savings account while I figured out how my receipts would turn out. Now that I’m doing payroll to move the money into the 401K, I realized I needed to pay FICA on it, reducing the total to $31K.
@Ren
Thanks so much for the fast response! This is my first year doing 401k payroll only (usually it’s combined with a regular payroll) and I was a bit shocked by the FICA taxes. Didn’t realize the difference when it’s not bundled… classic user error. Haha.
@Kelley
So, if you’re doing an extra payroll for the employee contributions (so your total W-2 wages for the year will be $50K plus the employee contributions), it’s probably best to do the employer contributions first. You could also consider ‘repaying’ wages from earlier in the quarter and then contributing them to the solo-401k as employee contributions. You’d have to amend your payroll reports if you do this, though.
@Tavi
Got it, the overall wages will be $50K plus the employee contributions. I definitely don’t want to amend anything. The contribution money is in the corporate HY account, so I understand now: I’ll transfer amounts to 401K for each employee/employer contribution, report via off-cycle payroll, and pay extra taxes on the employee part. Thanks for the detailed responses, they’re super helpful!
@Kelley
How much has your S-Corp paid you in wages for October-December? Take home? I’m thinking you may not need to add the full amount of employee contributions to your payroll, you might just need to move some things around.
@Tavi
So far, I’ve been paid $4K in Q4, and I expect another $2K at the end of December. Total for Q4 is $6K. My pay was higher earlier in the year, but a few projects were canceled and I had to cut back.
The S-Corp can contribute that $4K plus the $2K to your 401k as an employee contribution. This way, you can put $6K into the 401k without adding more FICA taxes.
For your Q4 payroll filing, you’ll report the same amount of FICA wages, but your wages will be lower due to the contributions.
Also, if you increase your W-2 compensation to make more employee contributions, you can increase the employer contributions too. The more you pay yourself, the more the S-Corp can contribute.
Both employee and employer contributions affect your taxable income in the same way. Employee contributions reduce your taxable wage, while employer contributions are a business expense that lowers your taxable profit. Both flow through to your personal filing.
However, if you’re in a state with an S-Corp tax (like CA with 1.5%), it might be worth considering taking $12K as an employer contribution to reduce the business profit, and the rest as employee contributions.