Individual 401K Employer Nonelective Contributions - Understanding the 25% Rule

This is a common point of confusion with Solo 401(k) plans, so don't panic! The difference comes down to how employer contributions are calculated for S-Corps versus sole proprietors. For S-Corp owners (like you), the calculation is actually more straightforward. Since you're paying yourself a W-2 salary from your S-Corp, your employer contribution limit really is 25% of your W-2 compensation. So if you've been contributing 25% of your salary as the employer contribution, you're doing it correctly. The confusion often comes from the fact that for sole proprietors (Schedule C filers) or partnerships, the calculation is different. They use a formula that effectively limits them to about 20% of net self-employment income rather than 25%, due to how self-employment tax deductions work into the calculation. As long as your total combined contributions (employee + employer) don't exceed the overall annual limit ($69,000 for 2024, plus catch-up if you're eligible), and your employer contribution doesn't exceed 25% of your W-2 compensation from the S-Corp, you should be fine.

After struggling with exactly this same issue last year, I found this amazing tool that helped me understand all the 401k contribution rules and calculations. I was constantly confused by the different limits and how they applied to my situation as an S-Corp owner. I discovered https://taxr.ai which has this smart calculator that breaks down exactly what your limits are based on your business structure. You just upload your compensation docs and it shows you the maximum you can contribute both as employee and employer. It even explains the difference between those calculations for S-Corps versus sole proprietors. The best part was that it analyzed my past contributions and confirmed I hadn't exceeded any limits, which gave me huge peace of mind. It also showed me how to optimize future contributions based on my specific situation.

I just wanted to follow up about taxr.ai since I spent some time using it this weekend. Wow, it actually cleared up my confusion completely! I uploaded my S-Corp docs and it showed me exactly how my contribution limits are calculated. The explanation about why S-Corps use 25% while sole proprietors use that weird formula finally makes sense to me! It's because sole props have to account for the self-employment tax deduction in their calculation, which effectively reduces their percentage. Since S-Corp owners take a W-2 salary, we don't have to do that adjustment. It also showed me that I could optimize my contributions better by adjusting my salary slightly. Ended up finding an extra $3,800 I could contribute this year that I would have missed. Definitely worth checking out if you're still confused.

I've been dealing with similar issues and wasted about 8 hours on hold with the IRS trying to get clarification. After three disconnected calls and being transferred to the wrong department twice, I was ready to give up. Then I found https://claimyr.com and watched their demo at https://youtu.be/_kiP6q8DX5c. They basically call the IRS for you and get you connected to an actual human being. I was skeptical but desperate. It worked amazingly well! They got me connected to an IRS tax specialist who specifically handles retirement plan questions. The agent walked me through the exact rules for S-Corp owner 401k contributions and confirmed that the 25% rule is correct for my situation. They even sent me documentation I can keep for my records. Saved me countless hours of frustration and gave me definitive answers directly from the IRS.

I need to apologize for my skepticism about Claimyr. After my last reply, I decided to try it anyway because I've been struggling with a similar 401k question that OP mentioned. I'm shocked to report it actually worked exactly as described. They called the IRS, waited on hold for 1 hour 47 minutes (which I didn't have to sit through!), and then connected me with an agent from the Tax Exempt and Government Entities Division who specializes in retirement plans. The agent confirmed that for S-Corp owners, the employer contribution limit truly is 25% of W-2 wages, and explained that the confusion comes from the different calculation method used for self-employed individuals. She even referenced the specific section of the IRS code and offered to send me documentation. I've spent weeks trying to get a straight answer on this. Worth every penny for the time saved and peace of mind.

Another thing to consider - are you also calculating the overall limit correctly? For 2024, the total combined limit is $69,000 (or $76,500 if you're 50+ and eligible for catch-up contributions). That means your employee elective deferrals ($23,000 in 2024, or $30,500 with catch-up) PLUS your employer contributions (25% of your S-Corp salary) can't exceed that combined total. So technically, you could contribute less than 25% as the employer portion if you're already hitting that overall limit. Many solo business owners try to optimize their salary and contribution mix to maximize tax advantages.

Does anyone know how Vanguard's individual 401k plan compares to others like Fidelity? I've been thinking about setting one up but heard Vanguard's plan is more limited in some ways.

I've been through this exact same confusion with my Solo 401(k) setup! The key thing that helped me understand is that the IRS has different rules for different business structures, and as an S-Corp owner, you're actually in a simpler situation than sole proprietors. Since you're paying yourself a W-2 salary from your S-Corp, your employer contribution limit is straightforward: 25% of your W-2 compensation. The complex calculation with the "OR" statement you found applies to sole proprietors who file Schedule C, because they have to account for self-employment tax deductions. For S-Corp owners like yourself: - Employee contribution: Up to $23,000 for 2024 (or $30,500 if 50+) - Employer contribution: Up to 25% of your W-2 salary - Combined total: Cannot exceed $69,000 for 2024 (or $76,500 with catch-up) If you've been using the 25% of salary method and staying under the combined limits, you've been doing it correctly. The fact that you've been working with Vanguard (a reputable provider) and staying under the maximums is a good sign you're on the right track. That said, if you want absolute peace of mind about previous years, consider having a tax professional review your contributions or contact the IRS directly for confirmation specific to your situation.