Reducing Taxes and Increasing QBI Deduction: A $300,000 S-Corp Owner’s Strategy with Traditional and Roth 401(k)
As a business owner, especially one structured as an S-Corp, finding effective tax strategies is crucial for maximizing profitability and ensuring long-term financial health. In this article, we will explore how a $300,000 S-Corp owner can leverage Traditional and Roth 401(k) plans to reduce their tax burden and enhance the Qualified Business Income (QBI) deduction.
Understanding Key Concepts
S-Corp Structure
An S-Corporation is a pass-through entity, meaning that the company’s income is reported on the owners’ personal tax returns. Although owners do not pay corporate taxes, they may still face substantial individual income tax liabilities.
Qualified Business Income (QBI) Deduction
The QBI deduction, introduced by the Tax Cuts and Jobs Act of 2017, allows owners of pass-through entities like S-Corps to deduct up to 20% of their qualified business income, provided their income falls below specific thresholds. For the tax year 2023, the limits for single filers are $182,100 and $364,200 for joint filers, above which effective limits apply based on the type of business.
401(k) Plans
Both Traditional and Roth 401(k) plans are retirement savings accounts with distinct tax benefits:
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Traditional 401(k): Contributions are made pre-tax, reducing taxable income for the year they are contributed. Taxes are paid upon withdrawal during retirement.
- Roth 401(k): Contributions are made after-tax but allow for tax-free withdrawals during retirement, provided certain conditions are met.
Tax Reduction Strategy
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Contributing to a Traditional 401(k):
- With an income of $300,000, the S-Corp owner can contribute up to $22,500 to a Traditional 401(k) (for 2023). If they are over 50, they can add a catch-up contribution of $7,500, bringing the total to $30,000.
- This contribution lowers the taxable income to $270,000 ($300,000 – $30,000), which may also increase the QBI deduction. Specifically, the QBI deduction would now be $54,000 (20% of $270,000), a significant increase from the QBI deduction calculated on the original income.
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Maximizing Employee Contributions:
- The S-Corp can also make contributions as an employer. The total contribution limit for a 401(k) (including employee contributions and employer match) for 2023 is $66,000, or $73,500 for those over 50.
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Incorporating a Roth 401(k):
- After maximizing contributions to the Traditional 401(k), the owner can also opt to direct some or all of the additional funds to a Roth 401(k). The Roth contributions would not lower the current-year taxable income, but they provide a pathway for tax-free income during retirement. As tax rates may rise in the future, having a source of tax-free income can be particularly advantageous.
- Balancing Contributions:
- Balancing contributions between both plans can optimize the tax strategy. For instance, an S-Corp owner might contribute to the Traditional 401(k) to reduce current taxes and then make Roth contributions with any remaining funds. This strategy creates a diversified tax situation in retirement, allowing for flexibility based on one’s future tax obligations and retirement needs.
Conclusion
For the $300,000 S-Corp owner, the combination of Traditional and Roth 401(k) contributions presents a robust opportunity to reduce taxable income while also enhancing the QBI deduction. By strategically utilizing these retirement accounts, business owners can minimize their tax burden, facilitate substantial savings, and create a diversified income stream for retirement.
As with any tax strategy, it’s essential to consult with a tax professional to tailor these strategies to individual situations and ensure compliance with tax laws and regulations. With the right approach, tax efficiency can significantly contribute to the overall financial well-being of an S-Corp owner.
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Is it allowed to have a tax loss for the S corp on cash basis after funding the maximum employer match to a Roth 401k?
Travis, Thanks so much for explainging this. I have a question… doing books for an S Corp and I have alway hear that 60/40 is a good rule of thumb. 60 Wages 40 Distribution which would not be taxed just lower this basis in the company. With it being November and he is looking at around 350,000 in profit. Can they company just add to his solo 401k and reduce the 350,000. He is doing a SEP already Thanks for your imout.
So, let's move on to retirement when there's no real guidelines for percentage of Salary vs Distributions…oh boy, sounds crazy. Like walking blind into a fire-pit
My wife and I are high earners (not self employed). We're considering purchasing rental properties (inside an LLC / S-corporation) to reduce our taxable personal income. Is this the correct route or is there a better way?
Through research, I actually knew almost all of this already; but had I found this video originally, it would have definitely been a time saver to condense everything lol. Great video! Is there a good contact for you, Travis?
How did you get $41,473 for the fed
100k is probably not reasonable. You need to do a study and warn clients of possible problems. You have oversimplified.
does your distribution affect your total gross income when qualifying for tax credits or is it just the amount you make on the W2?
Thank you, very useful!
I am who you're talking about in this video. My bookkeeper told me yesterday that I'm going to owe $30K+ plus in taxes for the year of I don't do somethings before December 31st. We took my salary from $30k to $81k. Now I'm scrambling to figure out how to setup a SEP IRA or solo 401K. I'm considering whether to lease a car, which I wouldn't do otherwise. I also need to bring on another independent contractor to increase expenses, and buy computer equipment for my business that I've known all year I need to buy. What else can I do??? How much can I give to my church? What else??
Thanks for the video. I was SMLLC (sole proprietor) in 2021 (the year I was let go from my employer and decided to start my own business). I have been operating in 2022 under this current structure but I want to convert to an S-Corporation. I know Form 2553 needs to be completed. My question is when the S-Corp election would be deemed to start and is this date the date when I would be able to start paying myself a salary?
Thank you so much. 2021 is my first year with s-corp. I didn't have payroll service. Can i still deduct wages from my 1120-s???? thanks
I’m getting from this that the higher the w2 the more you save and more you put away for retirement? Is that correct?
If you are a single tax payer in this example, wouldn't you have an issue of your QBI deduction getting phased out? What would you do in this situation?
Nice video Travis. I did not understand where are the after-tax contributions coming from? From W2 or from distributions? In the first scenario with $50k W2, can I do a pretax employee contribution of $19.5k and then an aftertax contribution of $38k?
How are you calculating the federal tax amounts in both scenarios?
This is super useful. I've seen a bunch of articles / videos on this, but actually walking through an example really made it click.
I'm trying to wrap my head around why Federal income tax is more on the 100k side ($43,138), than the 50k side ($41,473). What is that number based on?
This is great – thank you!
Thank you, appreciate you taking the time to walk through this complicated – many -moving part – calculation. My brain hurts!
Hi