Updated July 28, 2026. Quick answer: For an S-corp owner-employee the contribution base is your W-2 wages and nothing else. The IRS states it directly: “Distributions you receive as a shareholder of an S corporation do not constitute earned income for retirement plan purposes.” So a solo 401(k) wins, because it adds an employee deferral on top of the same employer contribution — and because paying yourself a low salary to save payroll tax quietly shrinks the retirement plan you can fund.
The base is W-2 wages. Full stop.
This is the fact that decides the question, and it is the one most often stated loosely. The IRS is explicit: “You can’t make contributions to a self-employed retirement plan from your S corporation distributions.” Publication 560 says the same from the other direction — net earnings “don’t include income passed through to shareholders of S corporations.”
| 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% |
Why the solo 401(k) wins at the same salary
Both plans allow the same employer contribution — 25% of your W-2 wages, per IRC §404(a)(3)(A) and §404(h)(1)(C). The solo 401(k) then adds an employee elective deferral on top, and IRC §404(n) expressly keeps that deferral outside the 25% deduction limit. A SEP cannot do this at all: the salary-reduction version was closed to new plans after 1996 by IRC §408(k)(6)(H), so any SEP you could open today is employer-contribution-only.
The trap that is specific to S-corp owners. The usual advice is to keep your W-2 salary low and take the rest as distributions, because distributions escape payroll tax. But your retirement plan is built on that salary. Cut the salary and you cut the employer contribution by 25 cents on every dollar you moved — and if you go low enough, you cannot even fund the full employee deferral. The payroll-tax saving and the retirement contribution pull in opposite directions, and almost nobody models them together.
Where the advantage finally disappears
The deferral advantage shrinks as wages rise and vanishes once 25% of your W-2 alone reaches the annual additions limit. The crossover is a formula, not a fixed salary, because both limits move every year. And it never fully disappears if you are old enough for catch-up contributions, which sit outside that cap entirely.
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.