The IRA rules for an S corporation owner to establish a SEP IRA, SIMPLE IRA, Keogh plans, or other retirement plans for the employees are somewhat more restricted. However, S corporation owners are encouraged to establish any of retirement plans for the employees such as the SEP IRA, SIMPLE IRA, Keogh plans, Money Purchase, Profit Sharing, and 401k.
What earnings can an S Corporation owner use to calculate his/her retirement plan contributions?
In order for an S corporation to establish a retirement plan (SEP IRA, SIMPLE IRA, Keogh plans, Money Purchase, Profit Sharing, etc.) on behalf of a shareholder/employee, the shareholder/employee must be receiving compensation (i.e., W-2 wages) from the S Corporation.
How are the flow through income in S corporations effect SEP IRA, SIMPLE IRA, and Keogh plan contributions?
The flow-through income (S Corporation net earnings) from the S Corporation taxed to the shareholder is not considered compensation and is not subject to self-employment tax. Thus, this flow-through amount cannot serve as the basis for a retirement plan Contribution.
All of the net earnings of the S Corporation other than W-2 wages are “deemed” distributed and taxable to the shareholders each year whether or not amounts are actually distributed. The nature or type of the earnings flow through is the same as it was to the S Corporation.
S Corporation shareholders have some degree of discretion in characterizing income either as salary or flow through. Any amounts a particular calendar year shown as salary are subject to Social Security and Medicare taxes of up to 15.3%.