Here is a brief synopsis of the proposed strategy:
- Startup company running at a loss is a C Corp rather than a passthrough entity (e.g. SMLLC or S Corp).
- Do the losses derived from this entity need to be lumped together with the profits of passthrough entity in determining 401K contribution limits?
- Startup company running at a profit is a C Corp rather than a passthrough entity (e.g. SMLLC or S Corp).
- If the entity distributes dividends, do those funds constitute self-employment income for purpose of determining 401K contribution limits?
Thank you again for offering to look into the C Corp option. Although it won’t impact my client's 2019 limits, it could be a viable strategy for future years and/or other clients.
If your client has a C Corp and does not treat the C Corp as a passthrough entity, the losses from that C Corp do not flow to his personal individual income tax return. In other words, the profits and losses will not flow to him. The losses stay at the Corporate level and he does not claim those losses on his individual income tax return. If the C Corporation paid him wages, then he would have self-employment wages from the C Corporation and could use those wages to justify contributions to solo 401k.
If the C Corp distributes dividends, those funds do not constitute self-employment income because those are passive income items. No work was required to receive a dividend. The self-employment earned income taken from C Corporation must be subject to social security taxes.
The ability to contribute to the plan is based on the sum of earned self-employment income from all controlled businesses. With respect to a C-corporation, the ability to contribute is based on the w-2 wages received from the C-corporation and the C-corporation's losses (to your first question) or profits (to your second question) do not decrease or increase respectively the individual's earned self-employment income and therefore decrease or increase the ability of the person to make contributions to the Solo 401k.