Question on Individual 401K and Adding Spouse (At what cost)?

[brainsrus]

I recently read with interest WCI's recent blog post on how WCI's wife now is a co-owner of the blog and gets to participate in an individual 401K... I am exploring similar options for my wife and am a bit confused with how much of a payroll tax hit we would take and if it would be worth it...

Here is my situation:

I am an employed doc making around 380K per year as a hospitalist.

I have a 403b and already put in 18K/year into it...

In addition I will make close to 260 K (with around 200 K net profits) from moonlighting and consulting.

I have an individual 401K at Vanguard and put in 35K/year (projected) into it... I could put in more but WCI pointed out the 403B and solo401K interaction with regards to the 18K and ownership etc...

My wife is a teacher and makes around 50K (last year) and she puts in 18K into a 403B. However this year she is going to quit her current job in May (as we both are planning to move) and this will decrease the amount she is going to be able to put into her 403B as we both are going to take some time off from work and travel.

After reading WCI's post I thought - what if I employed my wife and that way she can get another place to complete her employee deferrals and also share in the 20% profits.

My question is if my moonlighting profits are 200K (and I have already paid the bulk of SE tax via my W2 employer) is my wife on the hook for the full amount (i.e., she has to pay SE tax of 15.3% on the 200K profits upto the IRS max of 118.5K)? In that case we would be paying close to 7t to 9K in "extra" taxes just to be able to put in around 10 to 20 K into her individual 401K...

Or am I reading this whole thing wrong?

Can I pay her a salary of around 20K so that she can defer 18K (a little less as she has put some money already this year into her 403B as an employee) as an employee of mine and also only pay the 15.3% on this 20K.

In addition I can also profit-share the employer portion (split the 20% of net profits into each of our individual 401K accounts) without having to pay additional SE Tax (the dreaded 15.3%) for my wife?

Just trying to see if this is even worth pursuing.

[jfoxcpacfp]

The maximum that an employer+participant (employee) that employer can contribute to a 401k and deduct is $53k or 100% of salary, whichever is less. You could also make a 25% profit sharing contribution of 25% of her compensation, but if you pay her only $20k, the max that can go into the plan is $20k (the $18k + $2k profit sharing). She would pay FICA taxes on 1/2 the profits of the business only if she owns 1/2 of the business. You cannot contribute more unless she either 1) earns more (which means more FICA) or 2) is an owner (which means more FICA). It's a balancing act, I agree.

[brainsrus]

Thank you MS. Turner... I am going to run the numbers and see if this is something we should pursue.

 

Brainrus

[jfoxcpacfp]

brainsrus wrote:

Thank you MS. Turner… I am going to run the numbers and see if this is something we should pursue.

 

Brainrus

Click to expand...

You're welcome. If you are in a state with income tax, you may be edging up on the 50% bracket. If you can contribute enough to move down a bracket, might be a good idea. As you said, you've got to play with the numbers to see where the breaks are.

Note that if your spouse does not otherwise work, paying FICA for her for a few years will probably be money down the drain since she will be able to claim a spousal benefit of 1/2 of yours when you begin claiming and it's doubtful she'll get that much on her own.

[brainsrus]

Thanks again Ms. Turner. She continues/will continue to work so don't mind FICA - Quick clarification. You said above that I can profit-share 25% of her compensation. So if her comp is 20K would the 25% of profit-share work out to 5K? Or even 4K if it is 20%. Just wondering how you got 2K in the above example? Sorry I am still trying to sort this all out.

[jfoxcpacfp]

She can defer $18k from her salary. The employer can add another $2k to her account ($20k - $18k = $2k). She cannot receive more in her account than her compensation.

The point that I was trying to make about FICA was this:

• The income is now in your name only. After the first $118,500 of earnings in your name, you drop down to Medicare only (2.9%) rather than paying a full 15.3% for FICA taxes.


• All of your wife's income will be taxed at 15.3%. That means the salary of $20k you pay her will be taxed at 15.3% in her name rather than at 2.9% in your name.

[brainsrus]

Thanks for clarifying.

I guess I was under the impression that I could pay her 20K (and this will be FICA taxed at 15.3% as you pointed out) and profit share another (25% or is it 20%) of her comp which will be 5k (or 4K) but that this 5K (or 4K) will not be subject to FICA Tax. Am I wrong? I could then adjust her "total" comp to be 25k or something like that.

Also this decreases our income tax (state and federal) as now this 18+5 (or4K) will be considered pre-tax income and thus will decrease our overall tax bill (we are in the 39.5% marginal bracket for federal). This decrease I think will work out to be in our favor even if we have to pay FICA taxes on the 20K (or is it 25K)/

 

I appreciate your patience with my questions.

[childay]

I believe Johanna is correct, you cannot contribute more than 20k as that is her total compensation.

https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-401k-and-Profit-Sharing-Plan-Contribution-Limits

 

[jfoxcpacfp]

The 20% comes into play when you are self-employed and have to adjust for 1/2 of the SE taxes.

What you described is to actually pay a salary of $25k, not $20k, and contribute that amount to the 401k. The point is that the total amount going into her 401k for the year cannot exceed her earnings. The total earnings is subject to FICA taxes. iow, you do not get to deduct a contribution to a 401k before computing FICA taxes.

[brainsrus]

Thank you for explaining...I get it now! The total comp is subject to FICA Taxes (both the "salary" that I am paying and the profit sharing). I do understand that on this amount we will be paying the 15.3% as opposed to 2.9% (Medicare) if we didnt pursue this. 

But the money I pay her (if she puts it all into the retirement account) is not subject to state or federal income tax? If this is true then I think that the decrease in income tax will offset the increased FICA Taxes that we would pay by doing this... If this is not true (the income tax part) then I dont think it is worthwhile for us to pursue this option. 

I want to make sure I am comparing apples to apples.

[jfoxcpacfp]

Kind of. Just to be clear - it's not that her income is not subject to state or federal taxes, but that you reduce her state- and federal-taxable income by the amount she contributes to the 401k. The amount that she contributes to her account will reduce her taxable income, but not her FICA-taxable income. The amount you contribute (as her employer) is a deduction to you and is not reported as income to her.

So, if she makes $25k, here's the way it works:

• $18k employee contribution: FICA taxable, but deductible from fed/state taxable income. Local taxes may come into play.


• $7k employer contribution: deductible by you through the business. Spouse pays FICA/fed/state but you deduct for fed/state.

So, to answer your question, yes, you get to deduct for federal/state and defer taxes on same.

 

[brainsrus]

This helps a ton Ms. Turner. Thank you for taking the time to answer my questions... I am going to run the numbers now and see if this is something that we should pursue.