other pre-tax options for 1099 contractor

[helix1500]

Hi my fiance and I will both be starting our jobs this summer after concluding our training. We both have 1099 contractor positions. We each established an S-corp and plan to each setup a Vanguard Solo 401K in addition to our own HSA. I was wondering if we should investigate the VRIP to have access to the admiral shares as well as look into DBP as other vehicles of pre-tax investments? We have plans of backdoor Roth contributions after taxes and that's why we were leaning with the 401K option over SEP-IRA.

Advice or thoughts on the options are much appreciated, thanks!

[litovskyassetmanagement]

Of course, if you are getting substantial 1099 income, both should be considered.  However, I have to caution you about DB plans.  You would need to run this for at least 3-5 years, so you can't just turn them on and off like you can with a solo 401k plan.  Also, you have to be at least 35 to consider a DB plan (ideally, closer to 40), and you have to make contributions into them at a certain level (that you specify), but you don't want to shift this level around every year.  You might be just fine maxing out a solo 401 for a while.  If your 1099 income is not stable, that's another reason NOT to have a DB plan.

[jfoxcpacfp]

 

helix1500 wrote:

I was wondering if we should investigate the VRIP to have access to the admiral shares as well as look into DBP as other vehicles of pre-tax investments?

Click to expand...

Given the facts presented, I don't believe so at this time. You might want to read this post from Kon along with WCI's comments at the end.

To address the title of your post, since you are set up as 2 s-corps (which I probably wouldn't have recommended), you should also set up a proper home office, if warranted, and establish an accountable plan for the costs, along with accounting for your mileage driving to your customers.

[helix1500]

Thanks for the information. I am only 32 so will hold of on any DBP until several years down the road and stick with maxing out the solo 401K for each of us. We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road?

[litovskyassetmanagement]

Do you plan to hire any employees?  Are you in a community property state?  If your answer is no to either, you should be ok.

Also, you need to set the salary correctly - not too low and not too high (just high enough to max out the 401k plan).  However, if you are getting say $500k in 1099 income, having a salary of $140k might be too low, so your CPA should counsel you on this.

If you are going to max out your solo 401k plans and absolutely want them at Vanguard, you can do the VRIP accounts to get access to the Admiral share funds and brokerage (which is not really necessary if you have the Admiral funds).  You will need to use a third party administrator though because Vanguard will not provide any administrative functions for that account.  I might suggest starting with a regular solo 401k account first, and THEN converting to a VRIP say after a couple of years of contributions.  Just get used to this process first.

[jfoxcpacfp]

helix1500 wrote:

We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road?

Click to expand...

Yes, I understand. The reason I would probably not have recommended (unless you are in CA) is because you will have to file 2 corporate tax returns and payroll for each corporation. The extra administrative cost is likely not going to be overcome by any tax savings, which are slim to none if you are the only employee (i.e. the only revenue generator). A SMPLLC would be reported on a Schedule C included with your 1040 and would not require payroll reporting. It is also easier to take the home office deduction this way.

Not an issue, just what I see as an unnecessary complication.

[litovskyassetmanagement]

jfoxcpacfp wrote:

helix1500 wrote:

We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road? 

Click to expand…

Yes, I understand. The reason I would probably not have recommended (unless you are in CA) is because you will have to file 2 corporate tax returns and payroll for each corporation. The extra administrative cost is likely not going to be overcome by any tax savings, which are slim to none if you are the only employee (i.e. the only revenue generator). A SMPLLC would be reported on a Schedule C included with your 1040 and would not require payroll reporting. It is also easier to take the home office deduction this way.

Not an issue, just what I see as an unnecessary complication.

Click to expand...

Here's the dilemma though.  If they make $200k-$300k each, their W2 still has to be at least $150k or so, so we can get away with doing solo prop/LLC.  However, if they make $400k+ or so, the extra payroll taxes start to stack up so it would make sense to distribute the rest.  There is a breakeven point somewhere, and it would depend on the 1099 income level I would think.  The costs of payroll/extra filing fees might be an extra $1k each or so, but 3.8% in payroll taxes does stack up for those higher incomes.

[helix1500]

Thanks so much for the detailed information. The 1099 for each of us will be roughly 350, there will be no employees and will be in TX. I was also considering a solo 401K with fidelity as it seems to have more options than Vanguard without having to go through a TPA.

[jfoxcpacfp]

Kon Litovsky wrote:

jfoxcpacfp wrote:

helix1500 wrote:

We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road? 

Click to expand…

Yes, I understand. The reason I would probably not have recommended (unless you are in CA) is because you will have to file 2 corporate tax returns and payroll for each corporation. The extra administrative cost is likely not going to be overcome by any tax savings, which are slim to none if you are the only employee (i.e. the only revenue generator). A SMPLLC would be reported on a Schedule C included with your 1040 and would not require payroll reporting. It is also easier to take the home office deduction this way.

Not an issue, just what I see as an unnecessary complication.

Click to expand…

Here’s the dilemma though.  If they make $200k-$300k each, their W2 still has to be at least $150k or so, so we can get away with doing solo prop/LLC.  However, if they make $400k+ or so, the extra payroll taxes start to stack up so it would make sense to distribute the rest.  There is a breakeven point somewhere, and it would depend on the 1099 income level I would think.  The costs of payroll/extra filing fees might be an extra $1k each or so, but 3.8% in payroll taxes does stack up for those higher incomes.

Click to expand...

Kon, where are you getting your calculations for the amount that should be distributed? Where did you get the notion that the W2 "still has to be $150k or so..." and "There is a breakeven point somewhere and it would depend on the 1099 income level I would think..." (emphasis added). Whether or not the taxpayer is audited, are you aware that they are expected to be paid market salaries, i.e. that they would go to work for a $150k salary if they were employed elsewhere? Otherwise, this can be construed as abusive by the IRS.

The point is that they are the only people producing income and, as such, I would presume (as would the IRS) that they are being paid the 1099 amount to produce rather than being paid a tip over and above what they are worth.

As I said earlier, if they have employees who are also involved in producing income, there would be money left for distributions.

[Zaphod]

jfoxcpacfp wrote:

Kon Litovsky wrote:

jfoxcpacfp wrote:

helix1500 wrote:

We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road? 

Click to expand…

Yes, I understand. The reason I would probably not have recommended (unless you are in CA) is because you will have to file 2 corporate tax returns and payroll for each corporation. The extra administrative cost is likely not going to be overcome by any tax savings, which are slim to none if you are the only employee (i.e. the only revenue generator). A SMPLLC would be reported on a Schedule C included with your 1040 and would not require payroll reporting. It is also easier to take the home office deduction this way.

Not an issue, just what I see as an unnecessary complication.

Click to expand…

Here’s the dilemma though.  If they make $200k-$300k each, their W2 still has to be at least $150k or so, so we can get away with doing solo prop/LLC.  However, if they make $400k+ or so, the extra payroll taxes start to stack up so it would make sense to distribute the rest.  There is a breakeven point somewhere, and it would depend on the 1099 income level I would think.  The costs of payroll/extra filing fees might be an extra $1k each or so, but 3.8% in payroll taxes does stack up for those higher incomes.

Click to expand…

Kon, where are you getting your calculations for the amount that should be distributed? Where did you get the notion that the W2 “still has to be $150k or so…” and “There is a breakeven point somewhere and it would depend on the 1099 income level I would think…” (emphasis added). Whether or not the taxpayer is audited, are you aware that they are expected to be paid market salaries, i.e. that they would go to work for a $150k salary if they were employed elsewhere? Otherwise, this can be construed as abusive by the IRS.

The point is that they are the only people producing income and, as such, I would presume (as would the IRS) that they are being paid the 1099 amount to produce rather than being paid a tip over and above what they are worth.

As I said earlier, if they have employees who are also involved in producing income, there would be money left for distributions.

Click to expand...

Agree, its never seemed worth the risk for the relatively minor tax savings when you count all the added hassles and costs (Cali).

[litovskyassetmanagement]

jfoxcpacfp wrote:

Kon Litovsky wrote:

jfoxcpacfp wrote:

helix1500 wrote:

We each established an S-corp for each of our jobs and we were not yet married. Is bothof us being set up at a S-corp going to cause any issues down the road? 

Click to expand…

Yes, I understand. The reason I would probably not have recommended (unless you are in CA) is because you will have to file 2 corporate tax returns and payroll for each corporation. The extra administrative cost is likely not going to be overcome by any tax savings, which are slim to none if you are the only employee (i.e. the only revenue generator). A SMPLLC would be reported on a Schedule C included with your 1040 and would not require payroll reporting. It is also easier to take the home office deduction this way.

Not an issue, just what I see as an unnecessary complication.

Click to expand…

Here’s the dilemma though.  If they make $200k-$300k each, their W2 still has to be at least $150k or so, so we can get away with doing solo prop/LLC.  However, if they make $400k+ or so, the extra payroll taxes start to stack up so it would make sense to distribute the rest.  There is a breakeven point somewhere, and it would depend on the 1099 income level I would think.  The costs of payroll/extra filing fees might be an extra $1k each or so, but 3.8% in payroll taxes does stack up for those higher incomes.

Click to expand…

Kon, where are you getting your calculations for the amount that should be distributed? Where did you get the notion that the W2 “still has to be $150k or so…” and “There is a breakeven point somewhere and it would depend on the 1099 income level I would think…” (emphasis added). Whether or not the taxpayer is audited, are you aware that they are expected to be paid market salaries, i.e. that they would go to work for a $150k salary if they were employed elsewhere? Otherwise, this can be construed as abusive by the IRS.

The point is that they are the only people producing income and, as such, I would presume (as would the IRS) that they are being paid the 1099 amount to produce rather than being paid a tip over and above what they are worth.

As I said earlier, if they have employees who are also involved in producing income, there would be money left for distributions.

Click to expand...

Like I said before, the salary should be set by their CPA to be appropriate.  But those making $400k+ will benefit from electing to be taxed as an S-corp.  Rarely would the W2 have to be higher than $250k.  It might fluctuate between $150k - $250k depending on the job.  I work with some clients making $600k+, and there is no question that they should pay themselves a reasonable salary and distribute the rest.

[jfoxcpacfp]

Kon Litovsky wrote:

But those making $400k+ will benefit from electing to be taxed as an S-corp.  Rarely would the W2 have to be higher than $250k.  It might fluctuate between $150k – $250k depending on the job.  I work with some clients making $600k+, and there is no question that they should pay themselves a reasonable salary and distribute the rest.

Click to expand...

Really? Again, what is your basis for advising your clients to do that and making a blanket recommendation on a public forum? You might be interested in learning what the IRS says.

[litovskyassetmanagement]

jfoxcpacfp wrote:

Kon Litovsky wrote:

But those making $400k+ will benefit from electing to be taxed as an S-corp.  Rarely would the W2 have to be higher than $250k.  It might fluctuate between $150k – $250k depending on the job.  I work with some clients making $600k+, and there is no question that they should pay themselves a reasonable salary and distribute the rest. 

Click to expand…

Really? Again, what is your basis for advising your clients to do that and making a blanket recommendation on a public forum? You might be interested in learning what the IRS says.

Click to expand...

Sure, I agree about reasonable compensation. This really applies to those doctors who try to pay themselves way under what the average for their specialty is, and there is rarely a reason to take more than $265k as a W2 though, even for a practice owner.

Another reason to be taxed as S-corp for those with $400k+ 1099 is if they want to have a solo DB plan. Not only would it be much easier to calculate the contribution, but if the income is fluctuating, a W2 ensures that you can still max out the contribution.

[jfoxcpacfp]

Kon Litovsky wrote:

jfoxcpacfp wrote:

Kon Litovsky wrote:

But those making $400k+ will benefit from electing to be taxed as an S-corp.  Rarely would the W2 have to be higher than $250k.  It might fluctuate between $150k – $250k depending on the job.  I work with some clients making $600k+, and there is no question that they should pay themselves a reasonable salary and distribute the rest. 

Click to expand…

Really? Again, what is your basis for advising your clients to do that and making a blanket recommendation on a public forum? You might be interested in learning what the IRS says.

Click to expand…

Sure, I agree about reasonable compensation. This really applies to those doctors who try to pay themselves way under what the average for their specialty is, and there is rarely a reason to take more than $265k as a W2 though, even for a practice owner.

Another reason to be taxed as S-corp for those with $400k+ 1099 is if they want to have a solo DB plan. Not only would it be much easier to calculate the contribution, but if the income is fluctuating, a W2 ensures that you can still max out the contribution.

Click to expand...

Did you even bother to read the IRS link I provided? I get it about the DB plan. When all you have is a hammer, everything looks like a nail.

[litovskyassetmanagement]

jfoxcpacfp wrote:

Kon Litovsky wrote:

jfoxcpacfp wrote:

Kon Litovsky wrote:

But those making $400k+ will benefit from electing to be taxed as an S-corp.  Rarely would the W2 have to be higher than $250k.  It might fluctuate between $150k – $250k depending on the job.  I work with some clients making $600k+, and there is no question that they should pay themselves a reasonable salary and distribute the rest. 

Click to expand…

Really? Again, what is your basis for advising your clients to do that and making a blanket recommendation on a public forum? You might be interested in learning what the IRS says.

Click to expand…

Sure, I agree about reasonable compensation. This really applies to those doctors who try to pay themselves way under what the average for their specialty is, and there is rarely a reason to take more than $265k as a W2 though, even for a practice owner.

Another reason to be taxed as S-corp for those with $400k+ 1099 is if they want to have a solo DB plan. Not only would it be much easier to calculate the contribution, but if the income is fluctuating, a W2 ensures that you can still max out the contribution.

Click to expand…

Did you even bother to read the IRS link I provided? I get it about the DB plan. When all you have is a hammer, everything looks like a nail.

Click to expand...

I've read the IRS link, and I've written memos to my clients for quite a while about this issue because I see quite often that the W2 salary level is not set appropriately.  However there is no hard and fast rule to setting salaries, and I won't get into a debate on this here.  How the salary is set is between the business owner and their accountant, and I'll leave it at that.