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Jul 17, 2017

S-Corporation Owners: Compensation & Retirement Plan Contributions

When a corporation makes an election to be taxed as an S-corporation, the owners’ individual retirement plan contributions must be based on eligible Plan Compensation.  For this article, a retirement plan includes 401(k) plans, profit-sharing plans, pension plans, and SEP-IRAs, Simple-IRAs, and SAR-SEPs. 

Plan Compensation is used for retirement plan contribution calculations, deduction of contributions, and application of certain IRS and plan-level limitations.

Owners of an S-corporation can basically receive 2 types of earnings from the corporation:

  • K-1 Income:  Each tax year, the net profit of the corporation will be reported to the individual owners on a K-1, which is then taxable to the individual on their Form 1040.  The S-corporation entity does not pay corporate taxes on the net profits because it is being passed-through to the owners.  Hence this is referred to as pass-through income and S-corporations are often referred to as “pass-through” entities.
  • W-2 Wages:  The owners of an S-corporation would also typically receive payment for services they provide to the business as you pay an employee for services, and those payments are recorded on a W-2 and usually subject to payroll taxes.

Plan Compensation:  The compensation (usually referred to as W-2 wages) is plan compensation for the company retirement plan, while K-1 pass-through earnings from an S-corporation will be ignored or disregarded. 

There are a variety of considerations when setting an appropriate level of wages for an owner, including reasonableness, payroll taxes, and retirement plan contributions.  However, K-1 earnings from an S-corporation would not be treated as plan compensation. 

Keep in mind that retirement plans have a dollar limit (or cap) set by the IRS on the level of compensation used for retirement plan purposes.  For 2017, the maximum compensation limit under IRC§401(a)(17) is $270,000.  If wages are in excess of this limit, anything over the IRS limit will be disregarded.  The IRS can change or modify the annual compensation limit so be sure to know the current limit when working with retirement plan contributions.

I encourage business owners to talk to their CPA and their retirement plan consultant about this topic to determine what level of wages is appropriate and how that will affect retirement plan contributions for the S-corporation owner.

~ Joy Hodgson, CPC, QKA