S-Corp vs Sole Prop: Which Squeezes More into a Solo 401(k)
Same income, different math: 25% of W-2 vs ~20% of net SE earnings. At what income does the S-Corp election pay for itself just from extra 401(k) room?
Many freelancers eventually face the question: should I switch from sole prop to S-Corp? The conventional answer is "around $80k of profit." That's mostly about Social Security tax savings. But the Solo 401(k) math adds another lens.
The mechanics
Sole prop: employer share = 20% of (Schedule C profit × 92.35%). The 20% looks weird but it's the result of the IRS letting you deduct the contribution before applying the 25%, which works out to 20% on the gross.
S-Corp: employer share = 25% of W-2 wages. Distributions are invisible. So the S-Corp owner's salary directly sets the 401(k) ceiling, and salary is something the owner controls.
Worked example: $200k net business profit
Sole prop: net SE earnings = $200,000 × 92.35% = $184,700. Employer share = 20% × $184,700 = $36,940. Plus $23,500 employee deferral = $60,440 total. Combined cap $70,000, so $9,560 of room is unused.
S-Corp paying yourself $90k W-2 / $110k distribution: employer share = 25% × $90k = $22,500. Plus $23,500 deferral = $46,000. The S-Corp setup with that salary actually contributes less.
S-Corp paying yourself $186k W-2 / $14k distribution: employer share = 25% × $186k = $46,500. Plus $23,500 deferral = $70,000. Full cap consumed. But you've now paid Medicare tax (2.9% above SS wage base) on the extra $96k of W-2, about $2,800 in extra payroll tax. Worth it for $9,560 more retirement room? At a 32% bracket, the contribution saves $3,059 in federal tax this year, so net loss is about $260 in year one. Long-term compounding usually pulls this positive.
The crossover income
For most freelancers the Solo 401(k) doesn't push the S-Corp election decision by itself. Below $200k, sole prop usually maxes the contribution room with no payroll tax penalty. Above $300k, the S-Corp election was already winning on Social Security tax savings ($150k+ of distribution avoiding 12.4% SS), so the 401(k) bonus is gravy.
Salary planning if you're already S-Corp
The "reasonable compensation" floor varies by profession. Tech contractors typically need $120k-$180k to defend against IRS audit. That comfortably hits the Solo 401(k) sweet spot. Lifestyle bloggers paying themselves $40k might be safe from audit but waste their 401(k) room. Talk to a CPA before lowering your S-Corp salary just to save Medicare tax.
The catch-up math
At age 50 the catch-up adds $7,500 of employee deferral, taking the combined cap to $77,500. To fully consume it on an S-Corp you need W-2 of $216k (so 25% × $216k = $54,000 employer + $30k employee = $84k, clipped back to $77.5k by the cap).