If you conduct a trading business in an S-Corp and plan on employee benefit plan deductions for 2016, you need to execute certain transactions at year-end. If you have a partnership, there are fewer steps to take.
S-Corp year-end planning for traders
Before the end of the year:
- Execute and pay officer compensation. Determine compensation based on the retirement plan contribution you want. (You should limit retirement plan contributions to net profits, and not fund plans if you have net losses in the S-Corp. You need this officer compensation to create earned income to have employee benefit plan deductions.)
- Establish a Solo 401(k) or defined benefit plan (DBP) before year-end. Contribute up to $59,000 in a Solo 401(k) and perhaps up to $200,000 or more with a DBP if you are 45 or older.
- “Use or lose” an S-Corp accountable plan before year end for reimbursing business expenses paid individually, including home office expenses.
In January 2017:
- Fund the Solo 401(k) “elective deferral” contribution: Up to $18,000, plus an additional $6,000 catch-up provision, if age 50 or older. Deduct the elective deferral from taxable wages on the W-2. The elective deferral is subject to payroll taxes.
- For an S-Corp: Add officer health insurance premiums to the officer’s W-2 taxable wages. The amount is exempt from payroll taxes, including FICA, Medicare and state workmen’s compensation. The S-Corp owner/officer should simultaneously take an AGI deduction for health insurance on his or her individual tax return. (Officer health insurance is quirky with an S-Corp).
- Prepare and e-file W-2s by Jan. 31 (new deadline this year).
- Prepare and e-file Form 1099-Misc for “non-employee compensation” paid to service providers, including independent contractors, by Jan. 31 (new deadline this year).
For payroll, we recommend a team at www.Paychex.com dedicated to the needs of our trader tax clients using S-Corps. Please contact us for their contact and related information.
To avoid under-estimated tax penalties caused by skipping quarterly estimated tax payments earlier in the year on the individual level, consider increasing tax withholding on officer compensation. The IRS treats payroll tax withholding as being made throughout the year, so that should lower under-estimated tax penalties if you generated most of your trading gains earlier in the year.
The S-Corp needs to qualify for trader tax status (TTS) for the IRS to allow it to have compensation and employee benefit plan deductions, including health insurance and retirement plans. The IRS does not permit an investment company to have these employee benefit plan deductions.
The IRS requires partnerships to treat compensation paid to partners as “guaranteed payments,” and it does not allow partners to have salary run through payroll. But, a trading partnership should not use guaranteed payments since the IRS views it as an investment company. A partnership may pay an administration fee to the owner/trader, but with partnership losses caused by these fees flowing through to the partner, it’s difficult for them to generate self-employment income (SEI). A partner needs SEI to have AGI-deductions for health insurance and a retirement plan. S-Corp losses do not flow through to the owner for SEI purposes, and that’s the reason I recommend the S-Corp structure for traders who want employee benefit plan deductions.
If you have a dual entity structure with trading partnership and S-Corp or C-Corp management company, you should be adhering to written agreements providing for administration fees and or profit allocation. The agreements must represent valid business relationships, operations and work performed.
To learn more, watch our complimentary recording: Year-End Planning For Entities: Payroll, Retirement and Health Insurance. The accompanying worksheet (on the recording page) highlights the differences in a Solo 401(k) vs. a defined benefit plan and tax savings at different levels of income. This content is dated Nov. 12, 2015, and it’s still useful for 2016 year-end tax planning as there are few tax changes from 2015. I expect changes in entity tax strategies with tax reform and tax cuts in 2017, so stay tuned for blog post updates. (Read Traders Likely To Benefit If Senate Rams Through Trump Tax Cuts.)
I suggest our entity clients contact their assigned CPA immediately to get started on valuable tax planning, including executing the above transactions on a timely basis. (Read Many Ways Traders Can Save Taxes Before Year-End. Please don’t wait until late December as we take time off for the holidays.
My partners Darren Neuschwander, CPA and Adam Manning, CPA contributed to this blog post.