Updated July 28, 2026. Quick answer: Your effective employer rate is 20%, not 25%, and the base is not what most articles say. It is net profit minus one-half of your self-employment tax, minus the contribution itself. “20% of net profit” is wrong — it leaves out the self-employment-tax reduction and overstates what you can put in.
Where the 20% comes from
Publication 560’s Rate Table for Self-Employed carries a 25% row whose value is 0.200000, with this footnote: the deduction for annual employer contributions “can’t be more than 20% of your net earnings (figured without deducting contributions for yourself).”
The arithmetic is that the contribution is deductible in computing the base it is a percentage of, so the rate has to be solved rather than applied: the reduced rate is the plan rate divided by one plus the plan rate. For 25% that is 0.25 ÷ 1.25 = 0.20.
Both “20%” and “25%” are correct — against different bases — and that is exactly why this gets mangled. 20% applies to net profit minus half your self-employment tax. 25% applies to that figure minus the contribution as well. “20% of net profit” is neither, and it is the version you will most often see. On a mid-six-figure net profit the self-employment-tax step alone moves the base by several thousand dollars, so the error is not academic.
| You are | The employer contribution is a percentage of | Effective rate |
|---|---|---|
| Sole proprietor / single-member LLC | Net profit, minus one-half of self-employment tax, minus the contribution itself | 20% |
| Partner in a partnership | The same net-earnings computation, on your distributive share | 20% |
| S corporation owner-employee | Your W-2 wages only. K-1 income and distributions add nothing | 25% |
So does the solo 401(k) still win?
At most incomes, yes — for the same reason as any other entity. The employee deferral stacks on top and IRC §404(n) keeps it out of the 25% deduction limit, while a SEP has no deferral available at all after IRC §408(k)(6)(H) closed salary-reduction SEPs to new plans in 1996.
One advantage that is genuinely yours and not the S-corp owner’s. The Roth catch-up requirement in IRC §414(v)(7) is triggered by FICA wages from the employer sponsoring the plan. A sole proprietor does not have FICA wages. That means the rule does not reach you, while it does reach an S-corp owner-employee at the same income.
Every dollar limit in this area is indexed and changes annually. The figures printed in the Code itself — $40,000 for the defined-contribution limit, $160,000 for the defined-benefit limit, $15,000 for elective deferrals — are 2001 and 2005 base amounts that will never be updated in the statute; IRC §415(d) and §402(g)(4) do the adjusting. Get the current year’s figures from the IRS cost-of-living notice for that year rather than from any article, including this one. Nothing on this page states a dollar amount for that reason.
Sources
IRC §404(a)(3)(A) and §404(h)(1)(C) (the 25% deduction limit); §404(n) (elective deferrals excluded from it); §415(c) and §415(d) (annual additions, and indexing); §401(c)(2) and §1402(a) (earned income); IRS Publication 560, Retirement Plans for Small Business, current edition (the Rate Table for Self-Employed and the Deduction Worksheet); IRS Retirement plan FAQs regarding contributions — S corporation.
This states what the cited authority says. It is not tax advice, and retirement-plan design turns on facts about your business and your other entities that no page can see. Every dollar limit referenced here is indexed and changes annually.