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This is really two questions. For this post, I'm going to use a very simple example.

I have a single-member LLC with an S-corp election. I am the only employee.

In 2023, my W2 wages were $66,000. My K-1 income was an additional $300,000.

I max out my employee contribution at $22,500.

QUESTION 1) How much can my employer contribution be and still remain tax deductible? I ask because I have seen conflicting answers from the IRS. I think it is either:

  1. 25% of my W2 wages, or $16,500 contribution that is completely deductible as a business expense.
  2. A reduced fraction of my net earnings up to the maximum allowed of $66,000. Because my K-1 income is so high, that means I could easily contribute the remaining $43,500 that is completely deductible as a business expense. This is based on Schedule C income per this doc: https://www.irs.gov/retirement-plans/self-employed-individuals-calculating-your-own-retirement-plan-contribution-and-deduction

So far I have operated as if #1 is the correct answer because K-1 income is reported on Schedule E and not on Schedule C. I'm looking for confirmation of this.

QUESTION 2) Now suppose we have the exact same situation, but in addition to my Solo 401k I also have a non-5305 SEP IRA (custodian has already filed Form 5306 and has approval).

If #1 is true above, then could I contribute another 25% of net earnings (K-1 income) up to the maximum of $66,000, and have that entire contribution be tax deductible as a business expense? In this case, that would be an additional $27,000 contribution ($22,500 employee Solo401k, $16,500 employer Solo401k, and $27,000 SEP IRA gives $66,000 total), of which the entire $27,000 is tax deductible as a business expense.

I base this on: https://www.fyoozfinancial.com/moneymatters-blog/retirementplanningforcoupleownedbusinesses#:~:text=The%20reported%20income%20from%20each,an%20extension%20on%20your%20taxes.

Please do not start suggesting alternate plans, etc. Please just tell me if this is correct and what the maximum allowed deductible contribution amount would be.

I know that if #2 in Question 1 is true then the SEP IRA is meaningless.

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    It would help if you'd add sources to your claims so that it would be easier to understand the context. When you're talking about K1 income - what type of income is that?
    – littleadv
    Commented Jan 7 at 4:32
  • Form K-1 income is income received from an S-corporation. An LLC with an S-corp election uses this to report profits from the business distributed to shareholders. It is a very basic form that any LLC with S-corp election must distribute to shareholders: turbotax.intuit.com/tax-tips/small-business-taxes/….
    – sparaps
    Commented Jan 7 at 4:35
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    Oh I get it, you were trying to shield "k1 income" from self employment taxes, but treat it as self-employment income for retirement. Well... tough break, it's all or nothing.
    – littleadv
    Commented Jan 7 at 6:21
  • @littleadv well it's always shielded from self-employment taxes because that's how K-1 income works for an owner of an LLC with an S-corp election. You still pay regular income tax on it.
    – sparaps
    Commented Jan 7 at 14:37

1 Answer 1

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Question 1: The employer contribution for an S-corp Solo 401k plan is based on W-2 compensation. K-1 distributions aren't included. So your 25% of W-2 wages calculation would be correct.

Regarding the IRS source, S-corp owners aren't considered self-employed.

Question 2: SEP IRA contributions for an S-corp are based on W-2 compensation. K-1 distributions aren't included. Since the SEP IRA would be for the same company (or a company controlled by the same people), the 25% of W-2 wages limit would be reduced by the amount of employer contributions made to the Solo 401k plan.

Regarding the Fyooz source, you can't double-dip on the compensation considered for an employer's contribution to a defined contribution plan (Solo 401k, SEP IRA, etc.).

Combining the two questions and given $66,000 of W-2 wages and $300,000 of K-1 distributive profits, your Solo 401k and SEP IRA contribution limits for 2023 would be (barring any other limitations):

  • Employee elective deferrals (Solo 401k): $22,500
  • Employer profit sharing total (combination of Solo 401k and SEP IRA): $25% * $66,000 = $16,500
  • Total plan contributions: $22,500 + $16,500 = $39,000

You would also be able to make voluntary after-tax contributions to your Solo 401k if your plan allows for it, but this would not be tax deductible.

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  • Regarding question 2: why can I not also do an additional $16,500 into the SEP IRA? I understand that a contribution would be capped at 25%, but why not an additional contribution into the other? I base this on: fyoozfinancial.com/moneymatters-blog/….
    – sparaps
    Commented Jan 7 at 4:56
  • @sparaps You can't double-dip for the employer portion. So if $66,000 is being used to calculate the employer portion of the Solo 401k, you'd have $0 left to calculate the allowable SEP IRA contribution.
    – Stan H
    Commented Jan 7 at 5:02
  • then why would an accounting firm start talking about using K-1 income for figuring contributions? Is this only valid in the context of partnerships? I guess this also makes the SEP IRA redundant.
    – sparaps
    Commented Jan 7 at 14:32
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    @sparaps only valid in the context of partnerships. The K-1 they're referring to is Schedule K-1 (Form 1065), but the K-1 you'll have is Schedule K-1 (Form 1120-S). Also to note, although it doesn't really impact anything here, Fyooz is a financial planning firm (Registered Investment Adviser), not an accounting firm.
    – Stan H
    Commented Jan 7 at 17:05

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