Executive compensation plans
for 's' Corp Owners
The role of Non-Qualified Retirement Plans in Small Business America deserves special treatment. A significant number of small businesses are 'C' Corporations taxed as an 'S Corporation' while others are Limited Liability Companies (LLC's) who are taxed as an 'S' Corporation or as a partnership.
The single owner 'S' Corporation is not able to defer income in the same way that is possible with a traditional 'C' corporation. The owner of a 'C' corporation can defer $100,000 of W-2 income. The deferral may place him in a lower income tax bracket, or enable him to avoid thresholds under IRS law that trigger certain taxes or phase-out certain deductions. These included the following for those who are married, filing jointly:
- $250,000 - for the Additional Medicare Tax that increases Medicare taxes from 1.45% to 2.35% on all income,
- $250,000 - for the Medicare Surtax (sometimes called the Investment Income Tax) of 3.8%,
- $318,300 - for the phase-out of itemized deductions such as the mortgage interest deduction, or the capital gains tax deduction,
- $436,300 - for the phase-out of personal exemptions ($4050) and standard deductions ($12,700),
- $470,700 - triggers increase in capital gains taxes from 15% to 20%
The income of the 'C' corporation is affected by the owner's deferral of $100,000. The income of the 'C' corporation increases by the amount deferred...$100,000 in our example. The married business owner who earns $400,000 a year must consider the impact of the deferral on his personal tax return and on the company's tax return.
As to his personal return, our hypothetical owner avoids federal taxes of 33% on the $100,000 deferred, and avoids state taxes of $100,000 for a total of $40,000 in income tax savings. The deferral also avoids the Obamacare taxes on $100,000 of income on joint income of $250,000, thereby saving an additional 4.7% in taxes, or $4700.
Last, the deferral of $100,000 allows our business owner to avoid the phase-out of his mortgage interest deduction and charitable deduction at joint income of $318,300. The preserves $36,000 in mortgage interest deductions and $30,000 in charitable deductions, a total of $66,000 in tax deductions.
The small business owner who uses a 'C' corporation can also use the tax strategy 'income splitting' whereby the $100,000 of deferred income is now taxed at the rates of a 'C' corporation. The tax rate on the first $50,000 of corporate income is 15%. The rate on the next $25,000 of income is 25% and on the last $25,000 deferred, a rate of 34%.
The small business owner who currently pays out enough salary and bonus monies to reduce the income of his 'C' corporation to '0' each year should consider the tax strategy of 'income splitting' to reduce his aggregate tax liability and use the lower taxes of a 'C' corporation to fund his retirement.
The 48 year old married owner who defers $100,000 a year in the above scenario saves $44,700 in personal income taxes and preserves $66,000 in interest & charitable deductions (which effectively is an additional $26,400 in income). In other words, the immediate benefit is $71,000.
His 'C' corporation pays federal income taxes of $22,250 on the $100,000 on income that resulted from the owner's deferral. That is far less than the $71,000 of personal income benefits that the deferral created.
THE nqdc pLAN....THE RETIREMENT PICTURE
The 2014 Newport Study noted that 73% of Fortune 1000 companies invest the monies deferred by their executives into Corporate Owned Life Insurance. If the 48 year old small business owner follows this model with an indexed universal life policy, his retirement income picture at age 70 will look as follows:
- Retirement Income of $482,838 a year,
- A Legacy Benefit to his family of $5M at age 88.
This is the model an 'S' Corp owner should consider in weighing whether to take advantage of the tax strategy of income-splitting as a C corporation with the ability to take advantage of the benefits of a Non-Qualified Deferred Compensation Plan. The next consideration is how the 'S' Corp owner avoids having his income subjected to 'double taxation' from 'capital gains taxes' and Obamacare taxes when he withdraws monies invested for retirement income. The article, S Corporation Owner and Non-Qualified Retirement Plans, is an introduction to this subject.