The Relativity of Risk

Targeting The Business Owner’s Max-Tax

Are you sure you are doing everything you can to save your clients taxes?

by Herbert K. Daroff, J.D., CFP, AEP

Mr. Daroff, a contributing editor to this magazine, is affiliated with Baystate Financial Planning, Wellesley, Ma. Visit

All too often, I hear that a client’s objective is to save taxes.  It’s easy to save taxes.  Just give all of your income and assets to charities. You save income taxes and estate taxes.

The goal is never to just “save taxes”.  The goal should be to maximize income net after taxes, inflation, and fees.  And, for your heirs to maximize their inheritance net after estate taxes, income taxes on retirement accounts, and fees.

So, what can a business owner do to maximize income net after taxes?

Let’s start with qualified retirement plans.  All employees who work for you at least 1,000 hours, who are at least age 21, and have worked for you for at least 1-year are eligible to participate in your company’s retirement plan.  If you own more than one company, for example, one S-Corp and one C-Corp, all employees of all companies who fit those requirements are included in the plan, provided you meet the “controlled group” and/or “related service group” tests.  So, don’t think that just because you set up a C-Corp to operate a portion of what was part of your operating S-Corp that you can set up a separate retirement plan just for those in the C-Corp.

Most companies today establish a 401(k) plan.  In 2018, the owner and the employees can contribute up to $18,500 to their individual account.  If the owner and/or other employees are at least age 50, they can contribute another $6,000 to their account.  The amount that the highly compensated can contribute (those making more than $120,000) is a function of the amount contributed by all other employees (including zeroes for those who are eligible but don’t contribute).

Therefore, the employer may need to make matching contributions to encourage contributions by all employees and to make the plan “safe harbor” so that the highly compensated employees can contribute their full $18,500.  Matching contributions are immediately vested.  A 401(k) plan is a “defined contribution” plan.  Profit sharing contributions can also be made by the employer to the employees’ accounts, including the owners’ accounts.  However, the total that can be contributed in 2018 is $55,000 for those under age 50, and   $61,000 for those age 50 and above.  Therefore, the employer can contribute up to $36,500 to profit sharing.  These funds can be subject to a vesting schedule.  Those employees who stay the longest, get the most.  Employees who leave before they are fully vested leave funds that are then allocated to those who stay.

Profit Sharing

The contribution to profit sharing can be a level percentage of your earned income for all employees.  The maximum compensation that counts is $275,000.  Therefore, 13.27% of $275,000 results in a $36,500 profit sharing contribution.  Alternatively, the contribution can be higher for those employees who earn more than the Social Security wage base ($128,400 in 2018) and lower for those who make less than that.  This is a so-called “Social Security Offset” design.  There are other designs, as well, such as the Age Based Compensation (ABC) or New Comparability design that rewards the oldest and highest paid employees, which are usually the owners.  This is done to level the playing field, since Social Security covers a larger percentage of the lower paid employees’ retirement.

If you want to shelter more than $55,000 (or $61,000 if at least age 50), you need to explore “defined benefit” or “cash balance” plans.  I started my career in financial services in 1973, developing systems for an anticipated pension reform law, ERISA, which became law in 1974.  From 1973 to 1986, we established lots of defined benefit plans.  From 1986 to 2003, we terminated lots of defined benefit plans.  Since 2003, we have established defined benefit plans, especially in pass through companies (e.g., S-Corp, LLC).  In 2018, a defined benefit plan can contribute the amount necessary to provide up to a $220,000/year retirement income.  In an overly simplified calculation without all of the actuarial elements, you could fund over $300,000/year for a 55-year old.


AgeContributionAccumulationDistribution AgeAccumulationDistribution

However, how much needs to be funded for all of the other employees, through matching, profit sharing, and defined benefit or cash balance?

Pay Your Employees… Or The Government?

As a business owner, would you rather pay your employees or your government?  The contributions made by the employer for defined contribution (other than 401(k) matching) and defined benefit are subject to a vesting schedule.

The company’s net profit, after all expenses, including the retirement plan contributions, is then subject to income tax.  C-Corps are now taxed at a level 21%.  Eighty (80%) percent of the Qualified Business Income (QBI) for pass through businesses (e.g., S-Corp, LLC) is taxable at ordinary income rates.  If the business owner is the top 37% tax bracket, that’s 29.6%.  If your pass through is one of the specified service or trade businesses, then the 20% deduction may be limited to $315,000 (married filing jointly, phased out through $415,000) or $157,500 (for all others, phased out through $207,500) which is the 32% tax bracket.  That’s 25.6% for that portion of income.

So, if all a business owner wants to do is to save taxes, you could:

  • pay higher interest rates on your bank financing;
  • pay higher wages and bonuses to your employees;
  • pay more for other employee benefits; etc.

Alternatively, you could maximize the net after tax income for yourself and your business.◊