How Social Security Works for Business Owners

Eric Rosenberg — April 7, 2018

Social Security is a government-backed retirement program. Workers across the country pay a Social Security tax each year in exchange for a payment each month in retirement, or if disabled in some cases. This retirement fund isn’t quite a guarantee. For the most part, workers from all backgrounds can count on social security. Still, there is a very special way as to how social security works for business owners. This is important to understand in order to get the most from your social security

Social Security is a sometimes controversial program. It seems a decade doesn’t go by without a government leader threatening that Social Security may run out of money. Some think the program should be canceled. For now, it is the law of the land. Plus, it’s something that would be incredibly unpopular to eliminate or reduce. As a business owner, how does Social Security work? Let’s dig in and find out.

Social Security is Funded by FICA Taxes

Social Security is a program funded by taxpayer dollars. For people with a regular job and an employer, Social Security taxes are withheld automatically from each paycheck as payroll taxes. You might see one line on your pay stub for Social Security and one for Medicare. Or, you could see them lumped together into one line labeled FICA. This stands for Federal Insurance Contributions Act. It’s the law that put the payroll taxes into place.

It is important to note that there is a limit on FICA taxes unlike income taxes. After you reach that limit you don’t owe any further taxes for the FICA program. For high-income earners and business owners who bring home six-figures each year, this cap limiting contributions can save a bundle. For the majority of Americans, you can expect to pay Social Security taxes on all of your income.

As a business owner, you may not get a regular paycheck with tax withholdings and deductions. That doesn’t mean you don’t owe the tax. Quite the contrary. You actually owe more. Employed worker’s contributions are matched by their employer. Yet, self-employed workers have to pay both sides of the tax. This taxation is called the self-employment tax. Self-employment tax has the same limits at regular worker’s FICA contributions. Yet, you may owe them through a quarterly tax payment or annual tax payment instead of a weekly, bi-weekly, or monthly basis.

Government’s Obligation to Pay Social Security Benefits

Some elected officials have warned that it may run out of funds, leaving young contributors to worry that they won’t get paid back in their retirement.

Let’s just nip that one in the bud right here. Social Security can’t run out of money. Even if the Social Security fund does run out of cash, the Federal Government still has to pay out Social Security payments to eligible recipients. The Treasury Department will essentially just write the checks from a different bank account. The government is obligated by law to pay Social Security payments to eligible Americans. Without an act of Congress to eliminate Social Security, the government has to pay.

How Business Structure Impacts Social Security Tax Liability

If you own a business as a side hustle, it may not have crossed your mind to register the business with your state government. That’s okay. I most cases, that is perfectly legal. Your business is considered a sole proprietorship by the government. If you have legal worries or bring in over $ 40,000 per year, you may want to consider registering as a legal entity like a limited liability corporation (LLC) or a corporation like a C-Corp or an S-Corp.

If you run your business as a sole proprietorship, LLC, or S-Corp and as a pass-through entity, where the business doesn’t pay any taxes directly and you pay taxes for the business on your personal tax return, you are required to pay self-employment taxes on your earnings. Even if you don’t pay yourself a regular paycheck, you can expect to pay this to the government come tax filing day.

But, there is an option to save for those who run an LLC taxed as an S-Corporation, a full S-Corp, or a C-Corp. This gets a little bit complicated and there are some costs involved. However, it may help save thousands of dollars in Social Security taxes each year.

Lower Social Security Payments Today Mean Lower Future Benefits

When you run an LLC taxed as an S-Corp or an S-Corp, you have a option to lower your taxes that many business owners don’t know about. Because it is complex, you may want help from a tax expert or accountant when putting this together for your business.

When taxed as an S-Corp, you can pay yourself a regular paycheck and take all additional profit as an owner draw or dividend. In this case, you only owe payroll taxes on the portion of your income that comes from the paycheck. In my case, I am a W-2 employee of my company, Narrow Bridge Media, Inc.. I get a weekly paycheck from an online payroll management service. That service withholds my FICA taxes for me and remits to the IRS. Any income I earn above that level is only taxed at my regular income tax rate.

Case Study: How Social Security Works for Business Owners

Let’s say you run a business that makes $ 100,000 per year in profit. If you were to pay yourself a paycheck of $ 40,000 per year, that means you don’t have to pay Social Security taxes on $ 60,000 of your income or more than half of what you bring in. That’s huge! Just beware that the IRS requires you to pay yourself a “reasonable” salary. Therefore, look at the average income for someone in your field and try to be honest. If you make your paycheck $ 5,000 and take $ 95,000 in owner draws, you can expect the IRS to come a-knocking.

In my business, this strategy saves me about $ 5,000 per year in taxes. It also lowers my Social Security earnings. Lower earnings mean a lower benefit in the future. If the savings are compelling enough, you will save a lot more in taxes than you would get back from Social Security from paying higher taxes.

Get the Maximum Benefit From Social Security

You can log into the Social Security Administration website to see your past Social Security earnings and what income you can expect from Social Security in the future based on this income rate. Do everything you can to minimize your taxes and maximize your benefit. Your personal finances are too important to ignore. Social Security is a big part of retirement planning and savings for many Americans. Optimize your Social Security taxes and benefits with a focus on long-term results. The time and money invested are well worth it.

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