Only W-2 wages count
For retirement plan purposes, an S corporation owner who works in the business is an employee of the corporation. The plan's idea of your pay is your W-2 wages from that corporation, capped at the compensation limit of $360,000 for 2026.
The profit that passes through to you on Schedule K-1, and any distributions you take, are not pay for this purpose. The IRS says so directly: distributions from an S corporation are not earned income for retirement plans. An owner who takes no salary at all has nothing the plan can count, and cannot be given a benefit.
This is the main difference from a sole proprietor, whose plan pay is worked out from the year's profit. See sole proprietors and single-member LLCs for that version.
Salary has to be paid by December 31, 2026
Wages count for the year they are paid through payroll. Once the 2026 payroll has closed, you cannot add 2026 salary, and you cannot relabel a distribution as salary after the fact. Any 401(k) salary deferrals also have to come out of 2026 paychecks.
The plan itself can be adopted much later, up to the corporation's extended return due date. So the salary decision often comes before the plan is signed. See cash balance plan deadlines.
How salary sets the limit
A cash balance plan is limited by the benefit it may pay at retirement (IRC 415(b)): the lesser of $290,000 a year or 100% of your average pay over your highest three consecutive years. Two phase-ins apply on top. The dollar limit builds up over your first ten years in the plan, and the pay limit over your first ten years with the business.
The result surprises people. In the first year, salary makes little difference for an owner who has been in the business ten years or more, because the dollar limit is only one-tenth phased in. Salary matters over the life of the plan: it caps the lump sum your account can reach. For an owner with only a few years in the business, it can limit the first year as well.
| Salary | Payroll tax on it | First-year maximum | Largest lump sum at 62 |
|---|---|---|---|
| $100,000 | $15,300 | $223,000 | $1,280,000 |
| $150,000 | $22,950 | $223,000 | $1,920,000 |
| $200,000 | $28,678 | $223,000 | $2,570,000 |
| $250,000 | $30,128 | $223,000 | $3,210,000 |
| $300,000 | $31,578 | $223,000 | $3,720,000 |
Going from $100,000 to $300,000 of salary raises the lifetime ceiling from about $1,280,000 to about $3,720,000. At the lower salary the account reaches its ceiling within a few years and contributions then have to stop or fall sharply. At the higher one there is room to keep contributing at a high level until retirement. Above $290,000 of average pay the dollar limit takes over and more salary adds nothing.
What more salary costs
Salary carries payroll tax that K-1 profit does not: 7.65% from the corporation and 7.65% from you, up to the Social Security wage base of $184,500, and 2.9% combined above it. The 0.9% Additional Medicare Tax applies to wages above $200,000 for a single filer or $250,000 for a married couple filing jointly. Once salary is above the wage base, each extra dollar costs much less in payroll tax than the dollars below it, as the table shows.
There are two other effects to weigh:
- The QBI deduction. Salary is not qualified business income, so moving profit into salary can shrink the 20% deduction for owners who qualify for it. On the other hand, for owners above the income threshold in a business that is not a specified service, the deduction is limited by W-2 wages, and your own salary counts toward that. See the QBI deduction and retirement contributions.
- Reasonable compensation. The IRS expects an S corporation to pay an owner who works in the business a reasonable salary for the work before taking distributions. The usual concern is a salary set too low, so raising it to support a plan rarely runs into this rule. The figure should still reflect the work you do.
The right salary depends on your age, how long you intend to run the plan, your tax bracket and your state. It is a decision to make with your tax adviser, before the last payroll of the year.
Paying for the contribution
The corporation makes the contribution and deducts it on its Form 1120-S. The money comes out of the profit left after your salary and the company's share of payroll tax, and the deduction lowers the ordinary income that passes through to you on your K-1. So the business needs enough profit after salary to fund the contribution it wants to make.
Employer contributions to a qualified plan are not wages, so the contribution itself carries no Social Security or Medicare tax. Your own 401(k) salary deferrals are different: they reduce the wages taxed for income tax, but Social Security and Medicare still apply to them.
If the corporation also sponsors a 401(k), its profit-sharing contribution is generally held to 6% of your W-2 wages in years when the cash balance plan is funded, because of the combined deduction limit. Your salary deferrals are unaffected. See using a cash balance plan with a Solo 401(k).
Catch-up contributions must be Roth above $150,000
From 2026, if your Social Security wages from the corporation in the previous year were more than $150,000, any 401(k) catch-up contribution you make has to go in as Roth. It carries no deduction now. This is a rule that reaches S corporation owners and not sole proprietors, because only wages count toward the test. The details are in Roth catch-up contributions.
It rarely changes what salary makes sense, since the catch-up is small next to the cash balance contribution, but it does change how much of your total contribution is deductible.
Other points for S corporation owners
- State tax. Pennsylvania, New Jersey and Massachusetts do not let self-employed owners deduct these contributions, and an S corporation's contribution for its owner can be treated differently. Massachusetts allows it; Pennsylvania and New Jersey are believed to, but that has not been confirmed. See states that tax retirement contributions.
- Co-owners. A solo plan relies on the business being owned by you, or by you and your spouse. Whether a plan for a corporation with two unrelated shareholders stays outside ERISA Title I is unsettled. See who can have a solo cash balance plan.
- A single-member LLC taxed as an S corporation follows everything on this page. The S corporation election is what moves plan pay from profit to salary.
To see your own figures, the cash balance plan calculator asks for salary and profit after salary separately.