Resources

S Corporations: Why the Owners’ W-2s Matter for Retirement Plan Contributions

S-corporation payments to shareholder-employees are generally split between W-2 compensation and pass-through distributions. While distributions can be tax-efficient from an employment-tax perspective, shareholder-employees must still be paid reasonable compensation for services performed, and distributions generally do not count as “compensation” for qualified plan contribution purposes. As a result, an owner who minimizes W-2 wages may also be unintentionally limiting retirement savings opportunities.

Why W-2 wages drive retirement contributions.
For S-corp shareholder-employees, plan compensation is generally based on compensation reported on the shareholder-employee’s Form W-2 (as defined by the plan and limited by the applicable compensation cap under 401(a)(17)). This compensation is used to determine elective deferrals in a 401(k) plan, employer contributions, allocations under cross-tested or new comparability designs, and may materially affect benefits and contribution levels in a defined benefit plan. If W-2 wages are too low, the owner may not be able to maximize retirement benefits, even if the business has ample profitability.

2026 limits as context.
For 2026, the elective deferral limit for 401(k) plans is $24,500, with additional catch-up contributions potentially available. Total defined contribution annual additions are limited to $72,000 (excluding catch-ups). Compensation taken into account is generally limited to $360,000.

For example, an owner with $70,000 of W-2 wages can defer up to $24,500, but total annual additions for the participant cannot exceed 100% of compensation, and employer contributions may be further limited by the plan’s formula, nondiscrimination rules, and deduction limits. In a typical owner-only or pro rata profit-sharing structure, the owner generally cannot reach the $72,000 annual-additions limit without significantly higher W-2 wages.

Balancing tax efficiency and retirement goals.
The planning challenge is not simply to minimize W-2 wages. Instead, it is to strike an appropriate balance between employment tax efficiency (lower W-2, higher distributions) and retirement plan optimization (higher W-2, lower distributions). When advising S-corporation owners, retirement planning should be considered as part of overall compensation strategy. A focus solely on minimizing W-2 wages can inadvertently undermine the client’s ability to maximize tax-advantaged retirement contributions.

Jesse St. Cyr, Partner, Poyner Spruill
Jesse is a member of the Employee Benefits and Executive Compensation team at Poyner Spruill LLP. He represents clients before the IRS and DOL in matters involving employee benefits. Jesse has experience working with a diverse range of benefits and compensation matters and has extensive experience working with a variety of employers. Jesse is recognized by Chambers USA as a leading lawyer for Business (Employee Benefits & Executive Compensation).