S-Corp - who pays what taxes?

[Flow to the Max]

I feel like this should be straightforward after reading the WCI article on S-Corp, but I was hoping to clarify a few things:

Example for a given calendar year (S-Corp, hospitalist, no other employees)
S-Corp income: $300,000
W2 salary for employee: $150,000
Employer 401k contribution: $40,000
Distribution: $50,000

1. For the distribution going to the employee, this is just taxed as ordinary income without being subjected to payroll taxes. The business does not pay any taxes on this amount, correct?
2. The W2 wage of $150,000 is viewed as a business expense. The employer 401k contribution of $40,000 is also a business expense, correct?
3. If no employer contribution is performed, and instead the $40,000 is treated as a distribution, is there any tax ramification of this? Specifically, is the business going to end up paying taxes on that $40,000 that would have otherwise been viewed as an expense if it was used as an employer contribution? Or is the individual receiving the distribution just going to pay income taxes on it with no other consequences?
4. From the WCI article on S-Corp, it states “That means the taxes are passed through onto the corporation shareholders' individual returns. There is still a corporate return, but there is no payment made as a corporation.” To clarify, does this mean the S-Corp will never have to pay taxes but rather any net profits (or losses) will be passed on to the shareholder/employee and show up on their personal tax return (K-1)?
5. At the end of the year, if you have a remaining amount $20,000 of profit (after all W2 wages, contributions, and distributions), is this $20,000 of taxable money passed on to the shareholder to pay taxes on, even if no distribution is made? Or can this money sit in the business account “tax free” until a distribution is made?

Thank you!

[spiritrider]

Everything comes down to the fact that an S-Corp is a "pass-thru" entity of "active" income for tax purposes.

1. Yes
2. Yes
3. Ordinary Business Income is taxed as ordinary income regardless if actually distributed.
4. Passive income is taxed to the S-Corp.
5. See 3.

Are you really sure an S-Corp is the best choice? With $300K, it is likely of marginal benefit or maybe even detriment.

It is almost always best to have professional help with an S-Corp. At least for the first year or two.

[SeattleCPA]

Flow to the Max The S corporation profit in your example equals probably $300K minus $150K W-2 wages minus roughly $12K FICA minus $40K employer pension so $98K-ish.

This amount appears on box 1 of K-1 and gets reported on your 1040. And in your situation, because of the 199A deduction, you'll pay income federal income taxes on 80% of the $98K or roughly $78K.

The tax savings in this arrangement? You avoid some Medicare taxes. Maybe $5K? So not very much. But you also end up with a smaller 199A deduction. So I really agree with spiritrider 's general sense that this may not be "the best choice."

Sidebar: You can't actually do a $40K employer 401(k) match on $150K of wages. The max would be 25% of the $150K. So $37.5K.

BTW one thing that might make this arrangement work would be your state's pass-through-entity tax. Say, and this is using round and big numbers, that you owe state $10K in income taxes on the $98K of K-1 income. In that case, you might add $3K of federal tax savings to your list of S corporation benefits.

Another way to make this work is load up your S corporation with tax-free fringe benefits. E.g., if you pay yourself $100K (which is of course too low as a W-2 salary but stay with me)... and provide yourself with $20K of health insurance (which counts as W-2 wages but isn't subject to payroll tax)... and can some add a big $80K pension amount (like say $80K DB contribution)... now your comp equals $200K. So maybe that's reasonable. In this case, you add maybe $7K or $8K of payroll tax savings to the S corporation benefits list. And now this thing is starting, maybe, to make sense. But frankly this would all be a stretch in most cases. Note that in this case, your K-1 shows probably $80-$90K of income (80% of which you'll be taxed on regardless of how much you withdraw as a distribution.)

P.S. The rule for S corporations: You must pay reasonable shareholder employee compensation. If you don't, IRS can reclassify shareholder distributions and other payments to shareholders as wages.

[Flow to the Max]

spiritrider - Thank you very much for the help, so great! Is the S-Corp the best choice? I am struggling with this. When I started the job, the doctor I joined had an S-Corp and my CPA agreed. The S-Corp is $800 annually to maintain and very little effort. I work part time (~50%) so the realistic S-Corp income is likely closer to $250-275k. My spouse is W2 doctor with salary ~$450k, so we are over the income limit for 199A deduction.

- If I were to not do an S-Corp, moving forward, how do I evaluate the benefits of this decision? From my understanding, the only 2 other options are: 1099 vs LLC (California resident). I can't see a big reason to transition from S-Corp to LLC. And I can't grasp any major benefit of going pure 1099 other than simplicity of not needing to worry about S-Corp?

SeattleCPA - Fantastic points! And awesome strategies. I would love your input as well to the question above if you are willing to weigh in!

[SeattleCPA]

At this stage, you're an S corp for all of or some part of 2023. (I.e., you'll need to file return for year no matter what.)

Thus what I'd do is go through the year. Then get to end of year and see what you've saved.

You do want to make sure you do the PTET election. (First payment due in June. More info here: https://www.ftb.ca.gov/file/business...tax/index.html But your tax advisor will know how this works.)

P.S. Check with your attorney but I don't think a physician can use LLC in California. Thus, if S corp doesn't work, your practical other choice is sole proprietorship.