Section 199A Salary Optimization
Posted May 23, 2018
Given all that you’ve learned about Section 199A deduction limitations and phaseouts, such as W-2 and net business income, there is a magical percentage where your W-2 and net business income limits are the same.
You might have seen a number of 28.57%. This is practically correct, but technically incorrect since it does not factor in employer payroll taxes. We say practically correct since the difference is immaterial. Here is an analysis-
|Payroll Tax (Employer) @8%||2,000||3,200||2,235|
|Net Biz Income (NBI)||73,000||56,800||69,830|
|Section 199A W-2 Limit||12,500||20,000||13,968|
|Section 199A NBI Limit||14,600||11,360||13,966|
We assumed that employer payroll tax portion is 8% of the salary. This includes social security, medicare and unemployment taxes. This might be higher in some states, but let’s play along with 8%.
As you can see, the $25,000 salary (or 25%) results in Section 199A deduction being limited by W-2 amount. Next, the $40,000 salary results in Section 199A deduction being limited by net business income (NBI).
Using Excel’s solver plug-in, or manually changing the salary to bracket the two limits, results in a salary of $27,935 or 27.9%. This magical W-2 optimization for Section 199A deduction means that both W-2 and net business income limits are the same, and neither is specifically controlling.
Also keep in mind that as salaries increase beyond the social security wage and unemployment wage caps, the payroll tax portion will change resulting in a different equilibrium percentage. This is why we suggest that the 28.57% number floating around out there on the internets, yes, plural, is practical but not exact.
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