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Other W-2 Income
By Jason Watson, CPA
Posted Sunday, July 11, 2021
You might not reap all the benefits of an S Corp election and subsequent self-employment tax savings if you have other W-2 income. Let’s say you are an IT consultant for ABC Company, and you also do some outside consulting. If ABC Company pays you $150,000 in wages, you are already max’ing out your Social Security contributions, and therefore any supplementary income regardless of your entity will automatically avoid additional Social Security taxes.
You still obtain a small savings in Medicare taxes, which is generally immaterial at 2.9% or 3.8% of the side gig income. Then again, a tiny number multiplied by a big number can be a big number. We’ll talk more about when forfeited taxes exceed the reduction in Medicare taxes in a bit.
We find this to very common among medical professions. Many times, a surgeon or anesthesiologist will be full-time for a hospital or medical group, but also moonlight on the side for smaller towns with smaller hospitals with even smaller budgets.
The problem with piling extra W-2 salary from your S corporation onto W-2 salary from your main job is the S Corp’s portion of payroll taxes. While both salaries might exceed your individual Social Security cap ($142,800 for the 2021 tax year), any salary in excess will unnecessarily increase the tax burden of your S Corp by 6.2% (the employer portion of Social Security taxes). Huh?
In other words, your main job will stop collecting and paying Social Security taxes once you reach the annual limit. However, since Social Security taxes are paid by both the employee (you) and the business, when you run payroll with your S corporation, the business will collect and pay Social Security taxes just like your main job. On your individual tax return, you will get your excess refunded to you on Line 11 on Schedule 3 of Form 1040. That’s the good news. The bad news is that the S Corp’s portion will not be refunded. This is lost forever, and we call this a forfeited tax.
Here is yet another table to explain this further-
|Salary from Main Job||150,000|
|Income from Business||200,000|
|Medicare Tax w/o S Corp||7,600|
|Payroll Tax w/ S Corp|
|ER Social Security||4,092|
|EE Medicare w/ Surtax||1,551|
|Total Payroll Taxes w/ S Corp||6,600|
|Initial Savings||1,000||(7,600 less 6,600)|
|Fees for Payroll, Tax Prep (typical)||2,000|
|Net Savings (loss)||-1,000|
Ok… here we go. Let’s say you had a main job that earned $150,000 and you also run an online retailer business where you plan to make $200,000 net income after expenses. You eclipsed your Social Security maximum with your main job salary, so the $200,000 is only subjected to Medicare taxes plus the surtax, or $7,600 ($200,000 x 3.8%).
Now we elect S Corp for your business and pay a salary of $66,000. The total taxes paid not considering your portion of Social Security which will be refunded is $6,600. ER is short hand for “employer” and EE refers to “employee.” The initial savings is $1,000. However, now you have to run payroll and file a corporate tax return. Therefore, the savings are gobbled up by normal professional fees.
So, in this situation perhaps a garden-variety LLC is more prudent from a cost-benefit and headache analysis. Having other W-2 income, however, could actually work in your favor- more on that later.
Sidebar: Having multiple sources of income can mess up your withholdings. Each source of income on its own might withhold correctly, but when combined, the total income will be in a higher tax bracket and unfortunately have under-withheld as a household. Again, payroll tables don’t know about other jobs or sources of income and can only make assumptions. Some tax planning is a must. More about tax planning within your S corporation payroll in a later chapter.
Here is an internal table that we use during business consultations-
|28% Salary||33% Salary|
|ER social security||6.2%||6.2%|
|net biz income||200,000||275,000||200,000||275,000|
|delta (cash savings)||2,000||2,750||1,000||1,375|
Tilt. OMG. We have four scenarios; salaries of 28% and 33%, and business incomes of $200,000 and $275,000. Let’s take one and quickly dissect it.
The forfeited tax is your S Corp’s portion of Social Security taxes that must be paid but cannot be refunded. This is 28% x 6.2% or 1.7%. This 28% will be meaningful once we get into the Section 199A deduction.
The Medicare savings is the remaining S Corp income that will now avoid this tax. This is 72% x 3.8% of 2.7%. The 72% is in the inverse of the salary percentage.
The first delta is simply the forfeited tax less the Medicare savings, or 1.0%. The second delta is the calculated savings and it ties out to the first delta since $200,000 x 1.0% is $2,000.
Ok, enough of that nonsense. Please contact us if you want your unique situation projected and analyzed.
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