Tax Planning For S-Corps

September 22, 2023 | By: Robert A. Green, CPA

Read our related blog post and watch the webinar, Tax Planning For Traders.

Traders eligible for trader tax status (TTS) use an S-Corp to unlock health, retirement, and SALT deductions. It’s important to act before year-end using payroll. 

S-CORP OFFICER COMPENSATION

TTS traders use an S-Corp to arrange health insurance and retirement plan deductions. These deductions require earned income or self-employment income. Unlike trading gains, which are unearned income, a TTS S-Corp salary is earned income.

S-Corps pay officer compensation in conjunction with employee benefit deductions through payroll tax compliance done before year-end 2023. Otherwise, traders miss the boat. TTS is necessary since an S-Corp investment company cannot have tax-deductible wages, health insurance, or retirement plan contributions. A trading S-Corp is not required to have “reasonable compensation,” so a TTS trader may determine officer compensation based on how much to reimburse for health insurance and how much they want to contribute to a retirement plan. Remember, sole proprietor and partnership TTS traders cannot pay salaries to 2% or more owners; hence, the S-Corp is needed.

S-Corp wages impact the SALT cap workaround, hinges on net income after wages. If you fall into the QBI phase-out range, wages are required to increase the QBI deduction. This decision-making has many moving levers, so consult your CPA for year-end tax planning in early December.

S-CORP HEALTH INSURANCE

S-Corps may only deduct health insurance for the months it was operational and qualified for TTS. Employer-provided health insurance, including Cobra, is not deductible.

The S-Corp reimburses the employee/owner through the accountable reimbursement plan before the end of the year. Add the health insurance reimbursement to taxable wages, but do not withhold social security or Medicare taxes from that portion of W-2 compensation. The officer/owner takes an AGI deduction for health insurance on their tax return.

A taxpayer can deduct a contribution to a health savings account (HSA) without TTS or earned income.

S-CORP RETIREMENT PLAN CONTRIBUTION

TTS S-Corps can unlock a retirement plan deduction by paying sufficient officer compensation in December 2023 when results for the year are evident. Net income after deducting wages and retirement contributions should be positive.

If you want to, you must establish a Solo 401(k) retirement plan for a TTS S-Corp with a financial intermediary before the year’s end. Plan to pay the 100%-deductible “elective deferral” amount up to a 2023 maximum of $22,500 (or $30,000 if age 50 or older with the $7,500 catch-up provision) with the December 2023 payroll. That elective deferral is due by the end of January 2024. You can fund the 25% profit-sharing plan (PSP) portion of the S-Corp Solo 401(k) up to a maximum of $43,500 by the 2023 S-Corp tax return due date, including an extension, which means September 15, 2024. The maximum PSP contribution requires wages of $174,000 ($43,500 divided by a 25% defined contribution rate). The maximum contribution for those under age 50 is $66,000 for 2023. For those 50 or older, it’s $73,500 for 2023. Tax planning calculations will show the projected outcome of the various options of income tax savings vs. payroll tax costs.

Consider a Solo 401(k) Roth for the elective-deferral portion only, where the contribution is not deductible, but the contribution and growth within the Roth are permanently tax-free. Traditional plans have a tax deduction upfront, and all distributions are subject to ordinary income taxes in retirement.

Traditional retirement plans have required minimum distributions (RMD) by age 73 in 2023, whereas Roth plans don’t have RMD. (See SECURE Act 2.0 RMD rules at https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs.)

SALT CAP

TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 29 states enacted SALT cap workaround laws. Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

Generally, elect to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1 like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. Act well before year-end; otherwise, you might delay the benefit to next year.

HAVE YOUR NEW ENTITY READY ON JAN. 1, 2024

If you missed employee benefits (health insurance and retirement contributions) in 2023, consider an LLC with an S-Corp election for the tax year 2024. Or you may want a spousal-member LLC taxed as a partnership for 2024 to maximize the SALT cap workaround and segregate trading from investing.

If you want the new entity to be ready to trade on the first trading day of January 2024, consider the following plan. Form a single-member LLC in December 2023, obtain the employee identification number (EIN) online, and open the LLC brokerage account before year-end to be ready to trade as of Jan. 1, 2024. The single-member LLC is a “disregarded entity” for the tax year 2023, which avoids an entity tax return filing for the initial short year 2023. You can add your spouse as an LLC member on Jan. 1, 2024, creating a partnership tax return for 2024. 

If you want health insurance and retirement plan deductions for 2024, then your single-member or spousal-member LLC should submit a 2024 S-Corp election within 75 days of Jan. 1, 2024.

The partnership or S-Corp is a “new taxpayer” to make an internal resolution to elect Section 475 MTM on securities only for 2024 within 75 days of Jan. 1, 2024. Otherwise, existing partnerships or S-Corps must file an external 475 election statement with the IRS by March 15, 2024.