S-Corp organization is popular for small business owners, as a means of avoiding the 7.65% FICA on earnings, which instead are treated as dividends.

My question is maintaining a 401(k) plan within an S-Corp.

If an S-corp owner (sole employee) pays himself $20,000, will the 25% of participating payroll limit his TOTAL contributions from salary deferral and employer contributions to the 25% ($5,000), or does this 25% represent only the employer's contribution and 402(g) salary deferral will be in addition to this, with 100% of salary being the final limitation?

Thanks

When you refer to "the 25% of participating payroll", I presume that you are referring to the deduction limit. Salary deferrals are not taken into account for the deduction limit. Salary deferrals (but not catch-up contributions) are taken into account for the annual additions limit.

Therefore, if the S-Corp. owner pays himself $20,000 in W-2 wages, the maximum contribution will be $5,000 employer contributions ($20,000 X 25%) + $14,000. If he is age 50 by year-end, he may contribute an additional $1,000 as catch-up…or $14,000 + $4,000 catch-up + $2,000 employer contribution.

I assume we're talking about 2005. So, if S-Corp owner is 50 or older and pays himself $20,000, he can get:
$14,000 deferrals
$4,000 catch-up
$5,000 deductible employer contribution (25% of $20,000).
Total $23,000 in contributions.

I see no reason why he can't go over 100% of compensation if he's over age 50.

...what about the 100 percent limit?

Appleby, see http://benefitslink.com/boards/index.php?showtopic=28235

What advantage does an employee get by making contributions which exceed 100% of pay? An ee who has 20k in taxable income and contributes 23K to retirement plans loses 3k in deductible tax benefits. Most employees in the 15% tax bracket would be better off contributing 3k to a roth than to a deductible retirement plan. the 15% tax bracket is available to a married couple with 2 dependents with up to 80k in taxable income.

Mbozek, I don't understand your analysis. With an S-corp there still is the pass-through income to the owner that must be considered for individual taxes. The deferrals will lower the W-2 taxable income and the employer contribution will lower the pass-through amount. There is no loss of $3K in deductible benefits.

I think you will find that most sole owners of an S-corp aren't in business too long and certainly don't have a retirement plan if they are only making $20K.

I was responding to Wmyers post which took the position that a S-corp owner could contribute 23k to a retirement plan on 20k of income. My comment was focused on what tax benefit would the owner recieve if the deductible contributions exceed the max wages paid. I know Scorp owners with 20k or more in income who have SEPs because the Scorp is not their day job.

I still don't understand entirely your point even if your post is just in response to Wmyers' post. You said that there is a loss of $3k in retirement benefits. Where do you get this figure? You see if there were no pass-through income and all was paid as W-2 wages, there is a $5k employer contribution, which creates a $5k loss. If there was sufficient pass-through income, then the entire $5k is utilized that year. It's only if there was $2k in pass-through income before the contribution where the $5k employer contribution would cause a $3k loss that matches your figure. So you see why I don't understand the $3k figure?

Anyway, even if a loss was created, and I am no accountant for sure, couldn't this loss offset other individual income and be a benefit?

B: I dont understand your reponse. I will defer to the accountants but dont think that an S-Corp can pass through deductions for contributions to a retirement plan that exceed the amount of W-2 income paid by the S Corp and secondly under IRC 1366 the deduction for losses is limited to the amount of the S Corp owner's basis in the business. If The S corp owner contributed 1k in cash in return for 100% of the stock and the loss is 3k, the max loss passed through to the owner's 1040 is 1k.

I think the accountants are all busy this time of year. I can say though that my understanding is that an S-corp can deduct more than the W-2 paid.

Maybe but under IRC 1366 doesnt comp in excess of S corps owners K-1 income becomes a loss which is not deductible once it exceeds the owners basis in the S-Corp? Otherwise an S-Corp becomes an unlimited tax shelter for S-Corp owners who maintain a DB plan where deductible contributions exceed K-1 income and the lossses are deductible against taxable income of the owner on the 1040.

I doubt that you even have a loss in this situation. From what I have seen of most S-corps is that the owner pays a very small W-2 compensation and passes through the remainder of the income on the K-1.

For example, assume that the W-2 is $20,000 and the additional income of the corporation is $100,000. In that case, the participant would be able to defer $14,000 (for 2005) plus an additional $4,000 (if age 50), for a total deferral of $18,000 and net taxable W-2 income of $2,000. In addition, the coporation would make a contribution of $5,000 out of the $100,000 in net profits. The remaining $95,000 would be distributed on the K-1.

Lame Duck:

How would the scenario play out if the additional income to the corporation is only $1,000 rather than $100,000?

I am not a CPA, so don't quote me on this, but I believe the corporation would be limited to a deductible contribution that does not exceed the owner's basis in the corporation, plus the $1,000 in profit.

Thanks for the responses....I think I've got the picture now...although still not sure if total contributions to employee's DCP can exceed 100% of salary, as I've always understood the 415© limitation to be the lesser of 100% of salary or $42,000 (2005), with BOTH the ER and EE's contributions counting towards this limitation. Is my thinking incorrect?

As discussed in the link in Wmyer's post and as mentioned in the first response to your post by WDIK, the 415© limitation is an annual addition limitation. Catch-up contributions by definition are not annual additions and that is why they, when coupled with true annual additions, can exceed 100% of pay and exceed $42,000 in 2005.

So in short, yes, your thinking is incorrect.

As for the accounting questions before, I defer to a CPA post- 4/15.