Solo 401k and S election

[Suzanna Lam]

I just recently open a solo 401k for my business (single member LLC with me and my hubby being the members) with me being the trustee. So I am in control of my checkbook. So far so good.

My understanding is that I can contribute up to $49K of my earned income into this solo 401k. Fine I can do that.

Now, if I buy and flip, my earned income is subject to self-employment tax at 15% because of the flow through nature of the LLC. However, if I do my buy and flip in an S corp, that same income isn't taxed at 15% but 7.5%, give or take because the S-corp will pay the other 7.5%. Question is: should I elect to treat my single member LLC as an S corporation for tax purposes so that I personally wouldn't have to pay the 7.5% self-employment tax? The issue I'm running into is that if I elect to be treated as an S corp. my ability to contribute up the the max allowed for solo 401k is diminished because now I am an employee of an S corporation not a sole proprietor.

Does any one have any input? Thanks.

[J Scott]

First, I'm not an accountant, so take my advice for what it's worth...

Even if you have an S-Corp -- or an LLC taxed as an S-Corp -- you still pay the full 15.3% in self-employment taxes on an salary you pay yourself. Technically, you're responsible for 7.65% and the company is responsible for 7.65%, but because an S-Corp is a flow-through entity, you're essentially on the hook for both sides.

Now, the advantage that some companies will have by being taxed as an S-Corp is that they can pay dividends in addition to salary. The advantage being that you only pay the self-employment taxes on salary, NOT on dividends.

So, if your company earns $60K this year, that income flows through to you. If the entire $60K is paid to you as salary, you pay 15.3% on the entire amount. But, for example, if you can pay $40K to yourself as salary, and $20K to yourself as dividend, the $20K will not be subject to the 15.3% self-employment taxes.

The catch here is that the company MUST pay you a "reasonable salary" by IRS definition, before it can start paying out dividends. So, in the example above, if you try to pay yourself all $60K as a dividend, the IRS would not be very happy...

Hope that helps!