Solo 401(k) S Corp Rules vs Defined Benefit and SEP

The solo 401(k) S corp question usually arrives in December, framed as a plan question: which plan should the owner open? It's really a salary question. For an S-corp owner, the employer contribution is a percentage of W-2 wages, and distributions don't count. So the officer's salary sets the ceiling on what the corporation can put away, and the salary decision and the plan decision are one decision. Make them separately and one of them is wrong.

This guide compares the solo 401(k), the SEP and the defined benefit plan on that one axis: how much each can hold at a given salary, and what that salary costs in payroll tax. It also covers the adoption deadlines that make this a year-end conversation.

Why W-2 salary sets the contribution ceiling

An S-corp owner who works in the business is an employee of the corporation. The plan sees that person through the W-2. The employer contribution to a profit-sharing plan or SEP is deductible up to 25% of compensation paid (IRC §404(a)(3); §404(h) for a SEP). For the owner, compensation means W-2 wages. Distributions on the K-1 aren't compensation, no matter how large they are.

That's the whole mechanism. Illustrative example: an owner taking $60,000 in salary and $300,000 in distributions has a $15,000 employer-contribution ceiling. Move money from the distribution column to the salary column and the ceiling rises with it. Actual results vary based on income, industry, and state.

It also works the other way. The salary has to be reasonable before any of this starts, and a plan can't be a reason to pay less than that. How the salary figure is set and supported belongs to the reasonable compensation guide, and the salary vs. distribution breakdown covers the split. This article starts where they end: the salary is defensible, and the question is whether the plan is a reason to pay more.

Solo 401(k), SEP and defined benefit on the salary axis

Each plan answers the salary question differently.

All three count compensation only up to the $360,000 limit under IRC §401(a)(17). Sources: IRS COLA table and Notice 2025-67.

Solo 401(k)

The deferral side doesn't depend on salary size, as long as the salary covers the deferral. The employer side is where salary matters: 25% of W-2 compensation, until deferrals plus employer money reach $72,000. Catch-ups sit outside that cap (IRC §414(v)). One limit to check: the $24,500 deferral limit is per person across every plan the owner is in (IRC §402(g)). An owner who also defers at another job shares it.

"Solo" is a description, not a plan type. It's a 401(k) that covers the owner and no eligible employees. Once the S corp has eligible employees, coverage and nondiscrimination rules apply, and the 2026 thresholds that matter there are $160,000 for a highly compensated employee and $235,000 for a key employee.

SEP

A SEP has no employee deferral. Every dollar is an employer contribution at up to 25% of W-2 compensation, with a $72,000 maximum for 2026. It's simpler to run. On the same salary it holds less, because the owner gives up the $24,500 deferral that a 401(k) stacks on top.

Defined benefit

A defined benefit plan promises a benefit at retirement and funds it with contributions an actuary calculates each year. The benefit is capped at the lesser of $290,000 a year or 100% of the participant's average compensation for the highest three consecutive years as a plan participant (IRC §415(b)). Further reductions apply in some cases, such as a short period of plan participation.

So salary drives this plan too, only over a longer window. Illustrative example: an owner whose salary has averaged $150,000 can't be promised more than $150,000 a year, and the contribution needed to fund that promise depends on age and the actuary's assumptions. Actual results vary based on income, industry, and state. It's also a funding commitment: minimum funding rules apply every year (IRC §412), not only in good years. When a defined benefit plan runs beside a 401(k), combined deduction limits apply as well (IRC §404(a)(7)). The plan document and the actuary set the numbers. Your firm's file should show the salary history they were built on.

Illustrative example: what salary buys in each plan

Illustrative example, using 2026 limits as of 2026-09-23: an S-corp owner under age 50, no other plan, no employees. Employer contributions at 25% of W-2 salary.

At $190,000 the solo 401(k) reaches the $72,000 cap. A SEP needs $288,000 of salary to reach its $72,000 maximum. At age 50 the owner can add the $8,000 catch-up for $80,000; at ages 60 to 63, $11,250 for $83,250. One condition: if the owner's prior-year wages from the S corp were above an indexed threshold, catch-ups must go in as Roth (SECURE 2.0 §603; IRC §414(v)(7)). If the plan has no Roth option, that owner can't make catch-ups at all.

Now the cost. Moving the salary from $150,000 to $190,000 adds $40,000 of wages. Social Security applies to the first $34,500 of that, up to the $184,500 wage base, at 6.2% each for employee and employer: $4,278 combined. Medicare applies to all of it at 1.45% each: $1,160 combined. The employer doesn't withhold the additional 0.9% Medicare tax here, because withholding starts at wages above $200,000. Total added payroll tax: $5,438, to open $10,000 more of employer contribution room.

Actual results vary based on income, industry, and state.

Whether that trade is worth it depends on the owner's income tax picture, which this example doesn't model. The point is that the plan choice and the salary choice have to be priced together. A plan recommendation that doesn't state the salary it assumes isn't finished.

Year-end: the adoption deadlines

This is why the conversation happens in the fourth quarter. For a calendar-year S corp, rules as of 2026-09-23:

Two things follow for the file. Deferrals come out of salary, and the post-year-end deferral option open to sole proprietors doesn't help an S corp owner. The salary decision has to be made before the last payroll of the year, not at return time. And the employer contribution can wait for the return, but the salary it's based on can't change after Dec 31. That's why the plan item sits on the S-corp year-end checklist next to payroll, and why it gets its own section in the owner's S-corp tax planning memo.

What your firm's file should show

A Reviewer signing off on a retirement-plan recommendation is signing off on a salary assumption too. The workpaper should make both visible:

• The salary figure and where its support lives, whether that's a Reasonable Compensation Study or another documented method.
• The plan compared and the limit table used, with the as-of date.
• The contribution arithmetic at the recommended salary, line by line.
• The payroll tax cost of any salary above the reasonable-compensation figure.
• The adoption and deposit deadlines for the client's tax year.

The salary piece is the part that gets questioned first. The Reasonable Compensation Study is built for it: every figure traced to its source, and a Reviewer's sign-off on the file your firm keeps.

Conclusion

Pick the salary and the plan together. The salary has to be reasonable first. Above that, every dollar of W-2 raises the plan ceiling and carries payroll tax, and the recommendation should show both sides in numbers.

TracePrep ships one workflow today, the Reasonable Compensation Study, with traceable evidence and Reviewer sign-off on workpapers your firm owns. A tax-planning workflow is in development.

Get started or see how a Study is built.

Not tax advice. This article explains general rules and 2026 limits as of 2026-09-23. Apply them to a client's facts with your firm's own professional judgment.

TracePrep is a software product from TracePrep Inc., not a CPA firm. This content is operator experience for educational purposes; it is not tax advice and has not been reviewed by a licensed CPA. Consult a qualified tax professional for guidance on your specific situation. Source citations in TracePrep workpapers support audit defense but do not guarantee IRS outcomes.