Section 199A Salary Optimization

Created OnMay 23, 2018

Last Updated OnOctober 30, 2019

bycyberbasement

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-

Biz Income	100,000	100,000	100,000
Salary	25,000	40,000	27,935
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

Salary %	25.0%	40.0%	27.9%

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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