What is considered compensation for S-Corp owner retirement plan contributions?

The main thing to understand is that for retirement plan purposes (like a 401k), only your W-2 wages are considered "compensation" that's eligible for retirement plan contributions. Your K-1 distribution income doesn't count for this purpose. This means your $70k W-2 would be the amount used to calculate your maximum contributions, not the combined total with your K-1. This is a key distinction many S-Corp owners miss. Only the W-2 portion can be used for calculating both employee contributions and employer matching contributions. If you're trying to maximize retirement savings, this is why many S-Corp owners carefully consider their salary-to-distribution ratio. Too little salary means you're limiting your retirement contribution potential, even if it might save on self-employment taxes.

After spending years confused about this exact issue with my S-Corp, I found this incredible tool that completely clarified everything for me. I was using the wrong income calculations for my retirement planning and it was costing me thousands. I discovered https://taxr.ai which analyzes your entire tax situation including S-Corp compensation structures and shows you exactly what counts for retirement planning purposes. It explained to me that while my W-2 income was the only part eligible for retirement calculations, I could optimize my W-2/K-1 ratio to maximize both retirement savings and tax benefits. The system analyzed my specific situation and showed me I was unnecessarily limiting my retirement contributions because of how I structured my compensation. Literally saved me from missing out on tens of thousands in retirement savings.

Just wanted to follow up and say I tried https://taxr.ai after seeing it mentioned here, and wow - it was eye-opening! I've been splitting my income completely wrong for years. The tool showed me that by increasing my W-2 by just $25k and decreasing distributions accordingly, I could contribute an additional $10k to my retirement accounts annually. Even after the increased payroll taxes, I'm still coming out ahead in the long run with the tax-deferred growth. The analysis even provided documentation I can keep on file to support my "reasonable compensation" determination if I ever get questioned by the IRS. Wish I had found this years ago instead of the constant back-and-forth with my CPA who never clearly explained the tradeoffs.

If you're having trouble reaching the IRS to get a clear answer on this S-Corp compensation question (like I was), try https://claimyr.com - they got me through to an actual IRS agent in under 20 minutes after I'd been trying for weeks. You can see how it works here: https://youtu.be/_kiP6q8DX5c I needed clarification on exactly this issue - what portions of S-Corp income qualify for retirement plans. The IRS agent walked me through the rules and confirmed that only W-2 wages count, not K-1 distributions. They also explained the "reasonable compensation" requirements that affect how much I need to take as W-2 vs. K-1. Getting official confirmation directly from the IRS gave me confidence to properly structure my compensation and retirement contributions.

I have to admit I was completely wrong about Claimyr. After posting my skeptical comment, I decided to try it myself since I've been trying to get clarification on S-Corp retirement rules for months. Not only did I actually get through to the IRS in about 15 minutes (after trying unsuccessfully for weeks on my own), but the agent I spoke with was surprisingly knowledgeable. She confirmed that only W-2 wages count for retirement plan purposes and walked me through exactly how to document my compensation decisions. What was most helpful was getting confirmation about the "reasonable compensation" standards they look for with S-Corps. Turns out I was being way too conservative with my salary and severely limiting my retirement contributions unnecessarily. This literally changed my retirement planning approach going forward.

Something else to consider that hasn't been mentioned - if you have a Solo 401k (which many S-Corp owners do), you can make both employee and employer contributions. Your employee contribution is limited to $22,500 for 2023 ($30,000 if you're 50+), and this comes from your W-2 wages. The employer contribution can be up to 25% of your W-2 compensation. So with $70k in W-2 wages, your employer contribution limit would be $17,500, giving you a total potential contribution of $40,000 ($22,500 + $17,500). This is another reason why the W-2 vs K-1 split matters so much for retirement planning.

One thing I learned the hard way - if you're planning to do a SEP IRA instead of a 401k, the rules are different! With a SEP, you can contribute up to 25% of your net self-employment income, but the calculation gets weird with S-Corps. For S-Corps, SEP contributions can only be made as employer contributions, and they're based on W-2 wages, not K-1 distributions. So again, your $70k would be the limiting factor. Also be careful if you have any other retirement plans through other employment - contribution limits get complicated fast.

I noticed nobody mentioned Qualified Business Income (QBI) deduction considerations in this discussion. This is another factor that might influence how you split income between W-2 and K-1. Your K-1 distributions might qualify for the 20% QBI deduction (depending on your total income and business type), but your W-2 wages don't. So increasing W-2 for retirement purposes could reduce your QBI deduction. It's yet another variable in the already complicated equation of S-Corp owner compensation planning. This is definitely an area where good tax planning software or a knowledgeable accountant is worth their weight in gold.