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  • help with profit sharing decision

    I am a W2 dental practice owner, I currently pay myself 120k as an S corp. I started a 401k plan this year with Americas best 401k.
    The typical profit sharing calculation is typically done at end of year. However, since I am young and want to max my 401k contributions, we were wondering whether I should increase my W2 wages to 290k per year to make the profit sharing calculations more favorable. I dont want to do this if we end up not doing profit sharing because I would be paying unnecessary medicare taxes.
    My wife is a high earning professional as we are in a high high tax bracket. Below is what my accountant sent me based on the calculations from 401k company.


    "Based on the census I think it would be fine to go ahead and maximize the plan. The reason is as follows:




    - There is an increased cost in doing this as you see. The staff will receive about $14,000 in additional contributions.




    - We must also factor in that you will increase your medicare taxes by increasing the salary. This will cost you an additional $4,060 in taxes. This brings the total increase to about $18,000.




    - The tax savings would be about $16,555 and would almost offset the increased costs.




    In my mind, you essentially have to pay $1,500 to defer $25,000 of income. That's a pretty good trade-off as you will not need to draw the income for some time"

  • #2
    You're paying $1500 to invest the extra income while also paying your staff an extra $14k? Sounds like a win-win to me. Gov't is out on some tax money...

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    • #3
      Assuming the 14k to your staff is pre-tax from the company (you), your actual cost might be even lower, for example that is maybe 8k of after-tax income plus the 4k Medicare extra = 12k of actual after tax income loss for you, to save the 16,500 in taxes.

      Keep in mind of course that the $25k into your 401k is tax-deferred, so at some you’re still gonna pay and the math isn’t as blatantly favorable as it seems.

      That said I’d do it.

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      • #4
        Originally posted by abds View Post
        Assuming the 14k to your staff is pre-tax from the company (you), your actual cost might be even lower, for example that is maybe 8k of after-tax income plus the 4k Medicare extra = 12k of actual after tax income loss for you, to save the 16,500 in taxes.

        Keep in mind of course that the $25k into your 401k is tax-deferred, so at some you’re still gonna pay and the math isn’t as blatantly favorable as it seems.

        That said I’d do it.
        Yeah I just wondered what people thought about that math. If it was tax free forever, then it would be a no brainier but I will have to pay taxes later on. For comparison, I would pay taxes on the 25K +14K and put it in a brokerage account.

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        • #5
          I agree with abds. I would do it.

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          • #6
            i don’t think you should need w2 salary of 290k get to max profit sharing ($40,500). Max is 25% of Comp. Talk to your TPA and make sure plan design is optimized. Typically this is going to be a New Comparability method of testing. Also need to make sure that if you have health insurance and HSA and if this is an S corp that those amounts are being properly treated by payroll bc those amounts contribute to S corp shareholder Compensation in determination of profit sharing

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            • #7
              Originally posted by jacoavlu View Post
              i don’t think you should need w2 salary of 290k get to max profit sharing ($40,500). Max is 25% of Comp. Talk to your TPA and make sure plan design is optimized. Typically this is going to be a New Comparability method of testing. Also need to make sure that if you have health insurance and HSA and if this is an S corp that those amounts are being properly treated by payroll bc those amounts contribute to S corp shareholder Compensation in determination of profit sharing
              Correct, however, raising my comp to 290k makes the profit sharing math more favorable in my understanding. Unless I am incorrect.

              Comment


              • #8
                Originally posted by FluorideFreeVaccines View Post
                I am a W2 dental practice owner, I currently pay myself 120k as an S corp. I started a 401k plan this year with Americas best 401k.
                The typical profit sharing calculation is typically done at end of year. However, since I am young and want to max my 401k contributions, we were wondering whether I should increase my W2 wages to 290k per year to make the profit sharing calculations more favorable. I dont want to do this if we end up not doing profit sharing because I would be paying unnecessary medicare taxes.
                My wife is a high earning professional as we are in a high high tax bracket. Below is what my accountant sent me based on the calculations from 401k company.


                "Based on the census I think it would be fine to go ahead and maximize the plan. The reason is as follows:




                - There is an increased cost in doing this as you see. The staff will receive about $14,000 in additional contributions.




                - We must also factor in that you will increase your medicare taxes by increasing the salary. This will cost you an additional $4,060 in taxes. This brings the total increase to about $18,000.




                - The tax savings would be about $16,555 and would almost offset the increased costs.




                In my mind, you essentially have to pay $1,500 to defer $25,000 of income. That's a pretty good trade-off as you will not need to draw the income for some time"
                This is not enough information. What is the total employer contribution amount? What do the numbers look like with $120k? Chances are they don't look good and you probably can't even pass the testing. What is your net income? If it is lower than $400k, and you are very young, you probably shouldn't be doing a 401k in the first place. Going from $120k to $290k in 2021 (it is more like $305k for 2022) would require your net income to be possibly at least $450k so that you can comfortably max out PS and cover your employees. The cost of doing so is about $3.3k to go to max. SS. wage base and $5.6k up to $290k or so, or about $9k total, just to increase your W2. That however is not an issue at all if you get a lower employer contribution cost as a result. The question is, what is the cost in employer contribution for you at a W2 of $290k? And have they done any illustrations with a lower W2 to see if you can max out with a lower W2? Sometimes having a lower W2 increases employer contribution, but this would be offset by a lower payroll tax, so it is worth looking to see if you can keep going down in W2 if your net is not too high.

                This is why these illustrations have to be done before you start a 401k, not after. It sounds like to me that you opened a 401k sight unseen without doing a design study, and now, a few months into it, you are wondering about questions that should have been addressed by your service providers before you opened your plan.This is a warning to all docs/dentists not to be in a big hurry without first understanding the ins and outs of how to set your W2 and how the numbers would look. This decision is not to be made at the end of the first year, but prior to even considering opening a 401k in the first place. The problem is that sometimes the numbers are very ugly, and at that point you might not even want a 401k plan, but something like a SIMPLE IRA instead. I see plenty of 401k plans closed almost as fast as they are opened due to this issue, so do your due diligence.

                Here's what should have happened:
                1) A design study with various W2s should have been performed to optimize your W2 so that you knew exactly what it would be for your specific practice. If your net income from the practice is relatively high ($500k+), a 401k can be a good idea, but dentists have notoriously bad demographics (and are usually much younger than staff if they bought the practice), so this analysis should have been done thoroughly.
                2) Cost vs. benefit analysis to make sure the cost justifies the benefit. This is where you (or your service providers) do all of the analysis necessary to decide whether you want to max out profit sharing or not (and this depends on multiple factors, including your net income, tax status, etc). In some cases keeping W2 low and getting maximum QBI deduction is the way to go (and doing no profit sharing). In that case a 401k is probably not even necessary and a SIMPLE IRA would do. In the case of a higher tax brackets, 401k probably makes more sense, but all of this should be considered as part of the overall cost vs. benefit analysis. Make sure you understand where your breakeven point is (ballpark) if you are close to this point, so that if things change in the future, you know what the parameters are and how high the cost can go before you decide to forego profit sharing. An expensive 401k plan (in terms of employer contribution) can be sometimes fixed with a Cash Balance plan, but this would require the doc to be at least 40 or so (older is better if demographics isn't great), so not doing profit sharing is OK if your end goal is to eventually open a Cash Balance plan (and your net is $500k+ at least).
                Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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