Avoiding self-employment tax and maximizing retirement contributions

Question

This is a follow-up to the answer to this question.

Suppose you have a single-member LLC that makes $200k and that you would like to contribute the annual maximum of $54k to a SEP IRA.

Is it possible to elect S-Corp taxation to reduce self-employment (SE) tax and still max out the SEP? I was told that you couldn't because the LLC distributions would not be earned income. Is that correct?

Would just switching from a SEP IRA to a solo 401k allow me to do both (reduce SE tax and max retirement contributions)? Or would I need a C-Corp taxed as an S-Corp?

From the previous answer, it appears that there is a scenario that allows you to both, and I want to understand that better.

Answer 1

SEP is limited to 25% of the profits, so if the LLC's profit is 200k, the max you can put into retirement is 50K. The word "makes" in your question is ambiguous, but lets assume that you mean profit.

The solo 401K the company match is limited to the same 25%. However, more can be contributed as the employee can contribute their salary, and then the company can put in a match (really profit sharing) which can easily vault someone over the 54k limit.

In the case mentioned in the other question, the numbers would actually work out worse. The employee could only put in 18k, and the profit of the company would be something less than 100K (100k in salary plus other costs), so the max would be something less than 42k.

A better solution would be to pay the employee 50k, have them max, then provided the profit was still above 144k, the max could be contributed to the 401K.

Oh and you cannot do both a SEP and a 401K.

To me it is much more beneficial to do a solo 401K. You can be an S-Corp and do so. You may want to talk to your favorite brokerage about a solo 401K. Fidelity, E-Trade, and Schwab all offer free solo 401Ks. As far as Fidelity goes, you can call them and they can walk you through it.