Other W-2 Income

By Jason Watson, CPA
Posted Thursday, May 30, 2024

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. But there is a lot to unpack here-

• You have Medicare savings versus forfeited Social Security taxes.
• You have the pass-through entity tax (PTET) deduction that is only available in an S Corp or partnership environment.
• You have the qualified business income deduction (QBID) that might be wage limited once you hit the 32% marginal tax bracket.

These all interplay. We’ll start with forfeited Social Security taxes first.

Medicare Tax Savings

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 $170,000 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 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 ($168,600 for the 2024 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 portion of excess Social Security taxes 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	170,000
Income from Business	200,000
Medicare Tax w/o S Corp	7,600
Salary	66,000
Payroll Tax w/ S Corp
ER Social Security	4,092
ER Medicare	957
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)	2,700
Net Savings (loss)	-1,700

Ok… here we go. Let’s say you had a main job that earned $170,000 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 shorthand for “employer” and EE refers to “employee.” The initial savings is $1,000. However, now you must run payroll and file a corporate tax return. Therefore, the savings are gobbled up by normal professional fees.

Therefore, 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 will 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
Salary	28.0%			33.0%
ER Social Security	6.2%			6.2%
Forfeited Tax	1.7%			2.0%
K-1 Income	72.0%			67.0%
Medicare	3.8%			3.8%
Medicare Savings	2.7%			2.5%
Delta	1.0%			0.5%
Net Biz Income (profit)	200,000	275,000		200,000	275,000
Salary	56,000	77,000		66,000	90,750
Forfeited Tax*	3,472	4,774		4,092	5,627
Medicare Savings	5,472	7,524		5,092	7,002
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% or 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.

Wait! There’s more to consider when your main W-2 exceeds the SSA wage base.

Pass-Through Entity Tax (PTET) Deduction

We touched on this in an earlier chapter, but we need to bring it up again here. As you recall, with the Tax Cuts and Jobs Act, Congress wanted to limit state and local taxes (SALT) to $10,000. This means either state income taxes or real estate taxes, or both, were severely muted on their deductions.

States got creative and created a state tax that was deducted on partnerships and S corporations tax returns (otherwise called pass-through entities… or PTE if you are a cool kid) resulting in lower federal taxable income. This tax, paid by the PTE, is then credited on the business owner’s state income tax return (or in some cases the taxable state income is reduced by the PTE’s income). This is also called the great SALT work-around.

Cash is cash to a business owner whether it is spent by the business or the human, right? There are all kinds of rules, and not every business owner will benefit from the PTET deduction. Shocker, we know.

Bottomline is this- does it feel better to pay your state income tax with personal dollars or business dollars? It’s a bit rhetorical… no need to say it out loud or call us. However, you need to have a pass-through entity, which is either a partnership or an S Corp. A single-member LLC disregarded for tax purposes or a sole proprietorship does not qualify! Read more here-

wcginc.com/ptet

Qualified Business Income Deduction (QBID)

You are likely getting tired of this section, but there is one more consideration. As mentioned elsewhere, once your household taxable income reaches the 32% marginal tax rate, your QBID has a second test. If you are a specified service trade or business (SSTB) such as attorney, accountant, physician, consultant, etc. you are mostly hosed. But if you are not an SSTB such as a retailer or an architect or realtor or the zillion other business owners, then read on.

The qualified business income deduction is 20% of your business income. Easy. Once you hit the 32% marginal tax rate, then your QBI deduction is 20% of your business income or 50% of wages whichever is lower. Lower. As such, if you do not pay wages (complete with payroll filings and W-2s), you might be limited on your QBI deduction. Keep in mind that you cannot pay wages to yourself in a sole proprietorship or a single-member LLC that has not elected an S corporation election. You also cannot pay partners a wage in a partnership.

As such, you might have regular W-2 wages that exceed the Social Security wage base and you might still need to S Corp elect your business entity just to capture the full effect of the qualified business income deduction.

Net Net

What do we do with all this data? We compare all the possible savings to the additional fees associated with an S Corp which are specifically business entity tax return preparation (Form 1120S) and payroll processing. From there, a simple cost-benefit analysis is done. It is not all dollars and cents, however. Please recall from another chapter that S corporations enjoy a significantly lower audit rate risk than plopping all this side gig income and expenses on Schedule C of your 1040 tax return.

Make $200,000 with your W-2, and $150,000 with your used copier sales gig, and you live in California? S Corp is not shabby with about $7,500 in savings (factoring in franchise tax too by the way).

It is not all dollars and cents, however. Please recall from another chapter that S corporations enjoy a significantly lower audit rate risk than plopping all this side gig income and expenses on Schedule C of your 1040 tax return.

Ok, enough of that nonsense. Please contact us if you want your unique situation projected and analyzed.