The Situation
The "Promotion Penalty"
Client Profile
- New Junior Partner at a Private Equity Firm
- Income: $200,000 (Base + Bonus)
- Transition: W-2 Employee → K-1 General Partner
The Problem
As a W-2 Employee
You are a "Passenger." Your employer pays half your FICA taxes silently.
As a K-1 Partner
You become the "Driver." You are suddenly responsible for the full 15.3% Self-Employment Tax.
The Question: How do we stop the tax bleeding without sacrificing wealth accumulation?
The "Hidden" Cost
Understanding the FICA Trap
Most new partners focus on Income Tax. The real killer is Self-Employment (FICA) Tax.
W-2 Employee
Employer pays 7.65% silently
K-1 Partner
You pay full 15.3%
If you do nothing, your "promotion" comes with a hidden ~7.65% tax hike.
The Decision Tree
Choose Your Vehicle
We don't just "file taxes." We choose the entity structure that matches your current financial goal.
Which priority matters most to you right now?
PATH A: "I need to catch up on savings"
Goal: Maximize Net Worth
Strategy: The "Supercharged" Sole Prop
PATH B: "I need cash flow now"
Goal: Maximize Monthly Take-Home
Strategy: The S-Corp "Tourniquet"
Path A: The Retirement Play
Strategy: K-1 General Partner (Sole Prop)
The Mechanic
We accept the higher tax rate but use the K-1 status to unlock massive deductions.
Total Tax Paid
~$29,500 (Same as W-2)
The Wealth Shift
Pay yourself, not the IRS
Wealth Maximization
- Solo 401k: Contribution cap raised from $23k to ~$63k
- Health Insurance: Premiums become 100% deductible "above the line"
Verdict: You are "wealthier" on paper, even though your tax bill is the same.
Path B: The Cash Flow Play
Strategy: The S-Corp Hybrid
The Mechanic
We split your identity into "Employee" (Salary) and "Investor" (Profit) to artificially cap your taxes.
Total Tax Paid
~$24,800
Immediate Savings
~$5,000 Cash
How It Works
We pay FICA tax only on your Salary. The remaining profit is distributed 100% FICA-Free.
Verdict: You keep more cash today, but you sacrifice some retirement contribution space.
The "Tourniquet" Visualized
Stopping the Infinite Leak
Why the S-Corp Works for High Earners
- Social Security Tax: Caps at $184,500 for everyone
- Medicare Tax (2.9%): Never stops. It is infinite.
The S-Corp Fix
K-1 Sole Prop
Pay 2.9% on $500k = $14,500
S-Corp ($150k Salary)
Pay 2.9% on $150k = $4,350
Savings: $10,000+ per year
The Bottom Line
You Are Now a Business Enterprise
Stop Filing Like an Employee
W-2: Zero Control
You're a passenger. The IRS takes their cut before you see it.
K-1: Maximum Accumulation
Build wealth aggressively with expanded retirement contributions.
S-Corp: Maximum Cash Flow
Keep more money in your pocket today while still planning for tomorrow.
Which path fits your life?
The 5 Podiatrists & The "Simple" LLC
A Case Study on Partnership Tax Pitfalls
"Prime Step Podiatry" is a successful 5-doctor practice. They thought forming an LLC was just paperwork.
Then they handed us their books for a Tax Diagnostic.
We Found 4 Critical Issues
Each one could have cost them thousands in taxes, penalties, or lost deductions.
Here is how we fixed them. 👇
Issue #1: The "Creative" Allocation
"Can't we just give the write-off to Dr. Smith?"
The Story
The practice bought a new Cone Beam CT Scanner, generating a large depreciation loss. The partners wanted to allocate all that loss to Dr. Smith because she had the highest outside income.
The Tax Diagnostic Found
This allocation lacked "Substantial Economic Effect". IRS Rule: You can't allocate profits or losses solely for tax avoidance; the allocation must match the economic reality.
Our Fix
We restructured the allocations to align with the partners' actual economic burden, preventing the IRS from disregarding the write-off.
Issue #2: The "Salary" Trap
"Dr. Jones manages the clinic, so we pay him a salary"
The Story
Dr. Jones took a $50k "salary" for running the business side. The practice was withholding payroll taxes like he was an employee.
The Tax Diagnostic Found
Partners cannot be employees. This payment is actually a Guaranteed Payment.
Our Fix
We reclassified the payments:
- Practice: Gets a business deduction
- Dr. Jones: Reports ordinary income subject to self-employment tax, not W-2 wages
Issue #3: The New Guy
"Dr. New joined in November. He gets a full share, right?"
The Story
Dr. New bought into the partnership on November 1st. The partners wanted to give him a K-1 showing a share of the profit for the entire year.
The Tax Diagnostic Found
This violates the "Varying Interests" rule (IRC §706). You cannot retroactively allocate income to a partner for the period before they joined.
Our Fix
We applied the "interim closing of the books" method, allocating Dr. New income strictly from Nov 1 to Dec 31.
Issue #4: The Exit Strategy
"Dr. Founder is retiring and selling his share"
The Story
Dr. Founder sold his interest to the remaining partners. The remaining podiatrists paid a premium for his share, but the practice's assets (clinic building, X-ray equipment) were still sitting on the books at a low depreciated value.
The Tax Diagnostic Found
Without action, the remaining partners lose out on the tax deduction for the "premium" cash they paid.
Our Fix
We advised making a §754 Election. This adjusted the "inside basis" of the assets, allowing the remaining doctors to depreciate the true market value of what they just bought.
The Outcome
From Audit Risk to Tax Optimized
The Result
By navigating Subchapter K correctly, "Prime Step Podiatry" avoided:
❌ IRS Reallocations
Of profit distributions
❌ Payroll Penalties
On partner "salaries"
❌ Lost Deductions
Upon founder's exit
❌ Audit Exposure
From improper allocations
Partnership tax is notoriously complex. Don't guess.
Is Your Partnership Agreement IRS-Proof?
Partnership tax done right
We help partnerships and LLCs navigate basis, allocations, and liabilities so you can focus on your patients.
What We Handle
- Partnership allocations with substantial economic effect
- Guaranteed payments vs. distributions
- Varying interests and interim closings
- §754 elections for partner buyouts
- Basis tracking and capital accounts
Book your Tax Diagnostic today.
The $500K Entrepreneur's Retirement Dilemma
How we turned $500K in income into a $69K tax-deferred retirement strategy
Meet Sarah
Profile: Solo consultant, $500K gross revenue, Schedule C filer (single-member LLC)
Her Problem: Maxed out on traditional retirement savings. Regular 401(k) limit? Just $23,000/year. She wanted to shelter more income from taxes.
The Question
Should she stay a sole proprietor, or convert to an S-Corp? And what retirement plan makes sense?
LLC vs S-Corp: The Trade-Offs
Understanding the fundamental difference
Single-Member LLC (Schedule C)
- All $500K subject to 15.3% self-employment tax
- Simple: No payroll, one tax return
- Flexible: Easy profit distributions
- Limited retirement: $69K max via Solo 401(k)
S-Corporation
- Only salary subject to 15.3% tax
- Complex: Payroll setup, quarterly filings
- Rigid: "Reasonable compensation" requirement
- Retirement: SEP IRA capped at 25% of W-2 salary
Key Insight: S-Corp saves SE tax but limits retirement contributions. LLC pays more SE tax but allows bigger retirement deferrals.
The Solo 401(k) Advantage
Why Sarah stayed an LLC
The Math That Matters
As a sole proprietor with $500K net profit, Sarah can contribute up to $69,000 to a Solo 401(k):
2024 Solo 401(k) Contribution Limits
Employee Deferral: $23,000 (2024 limit)
Employer Contribution: 20% of (Net Profit - ½ SE Tax)
Total Possible: ~$69,000
The Calculation:
- Net Profit: $500,000
- Self-Employment Tax: ~$35,000
- Employer Contribution Base: $500K - ($35K ÷ 2) = $482,500
- 20% of $482,500 = $96,500 (capped at $46K for 2024)
- Total: $23K + $46K = $69,000
What If Sarah Chose S-Corp Instead?
The retirement contribution limitation
The S-Corp Scenario
Let's say Sarah elected S-Corp status and paid herself $150K reasonable salary, taking $350K as distributions:
Self-Employment Tax Savings
Only $150K subject to SE tax (not full $500K)
Saves ~$24,000
Retirement Contribution Limit
SEP IRA: 25% of W-2 salary
Limited to $37,500
The Trade-Off
S-Corp saves $24K in SE tax but loses $31.5K in retirement deferrals ($69K - $37.5K). For high earners prioritizing long-term wealth building, the LLC Solo 401(k) wins.
The Employee Complication
When Solo 401(k) is no longer an option
The Rules Change
Critical Limitation: Solo 401(k) only works if you have no employees (except your spouse).
When You Hire Your First Employee
Your Solo 401(k) must convert to a full 401(k) plan with:
- Employee eligibility after 1 year / 1,000 hours
- Employer matching or profit-sharing for all eligible employees
- Annual Form 5500 filing (if plan assets > $250K)
- Compliance testing (ADP, ACP, Top-Heavy)
- Higher administrative costs ($2,000-$5,000/year)
Alternative for Employers: SEP IRA or SIMPLE IRA become more practical once you have employees.
The Strategy We Implemented
Maximizing tax deferral while keeping it simple
What We Did
Sarah's Final Structure
Stayed as Single-Member LLC
No S-Corp election. Kept it simple with Schedule C filing.
Opened Vanguard Solo 401(k)
Low-cost, self-directed. No TPA or administrator fees.
Contributed $69,000 in Year 1
Invested in diversified index funds (VTSAX, VTIAX)
Tax Impact: $69K deferral at 35% marginal rate = $24,150 tax savings in Year 1
The 5-Year Results
Building wealth while reducing current taxes
Where Sarah Is Today
Total Contributions (5 Years)
$345,000
Current Balance (8% Growth)
$412,000
Tax Savings Over 5 Years
Annual $69K contribution × 35% tax rate × 5 years
~$120,750 in deferred taxes
Why This Worked:
- Remained solo (no employees to complicate structure)
- Prioritized long-term wealth over short-term SE tax savings
- Used low-cost Vanguard platform ($0 annual fees)
- Stayed disciplined with maximum contributions every year
The Bottom Line: For high-income solo entrepreneurs without employees, the Solo 401(k) is the most powerful retirement vehicle available—even with higher SE taxes.
