Why are Self-Directed Solo 401k contribution limits different for sole proprietors and single owner corporations?
QUESTION: My big question is why are solo 401k contribution limits different for sole proprietors and single owner corporations? I’m a real estate agent who is currently a sole proprietor but is considering incorporating as a business entity.
ANSWER: In response to your question above, the solo 401k contribution limits are the same regardless if the tax payer’s elf-employed business entity is taxed as sole sole proprietorship or as an S-corp. For example, for 2022 the annual solo 401k contribution limit is $61,000 or $67,500 if you are age 50 or older.
Less Income When S-Corporation
However, It takes less self-employment income to reach the maximum solo 401k contribution limit when the tax payer’s self-employed business is taxed as an S-corporation versus one that is taxed as a sole proprietorship. The reason for this difference is the net self-employment income figure from the sole proprietorship (i.e., line 31 of Schedule C) is reduced by 1/2 of self-employment income tax before the final solo 40k contribution figure is calculated. Whereas with an S-corporation, the solo 401k contribution is based on the gross W-2 wages and 1/2 of self-employment income tax DOES NOT reduce the annual solo 401k contribution figure.
For example, if you are under 50 and your business is taxed as an S-corporation (and you are not making any contributions to another 401k plan such as through a day job), then you would be able to contribute $61,000 for 2021 provided that you received at least $162,000 in W-2 wages from your self-employed business.