Chris Stein, CFP®
Social Security Reduction for the Self-Employed
In the complex world of Social Security and Taxes, there are always little “issues” floating around that could come back to harm you if you make decisions while being unaware of all the consequences. I am talking about legally reducing your taxes today and what effect you may see later on in your Social Security benefits. Although this can sometimes include employees, this issue mostly arises with self-employed individuals.
Consequences of Reducing Your Taxes Today
The full complexities of the tax code and the rules for small businesses are beyond the scope of this blog, but let me simply say that at times it is possible to LEGALLY reduce your income taxes AND/OR your FICA taxes by choosing how to pay yourself as a business owner, and by taking advantage of legal expense write-offs when doing your taxes. The popular train of thought is to do whatever is possible within a legal context to minimize your taxes today. Sounds good on the surface, but let’s consider some consequences in a few possible hypothetical cases…
You have not yet earned 40 “credits” – Elsewhere on this blog you will see that to qualify for Social Security retirement benefits you must earn “40 credits” in the system. If you are reducing your taxable income to below the threshold to earn credits you may rob yourself of qualifying for benefits at all. This issue affects very few people, but if you haven’t gotten your 40 credits and are approaching retirement you will want to watch this one closely.
You have many years of low reported earnings – Since your SS benefits are based on your 35 best indexed earnings years the earnings reported to SS matter. Since everyone’s earnings record is different it is hard to state the exact impact of your choice to reduce taxable income in any given year, but it is certainly worth looking at. It may very well be worth it to report higher earnings in order to push up your retirement benefit since that benefit will continue for the rest of your life with inflation adjustments. It is complicated to calculate exactly what a single year’s change in income will do to your benefit but definitely a conversation to be had with your CPA or Financial Planner.
You are subject to WEP – For those self-employed who were previously in a job that did not pay into Social Security (think government employees), they could be affected by WEP. This benefit reduction can be eliminated with enough years of what SS calls “substantial earnings”. If you can generate at least 30 years of these “substantial earnings” on your record you will completely avoid the WEP reduction, even if you have a government pension benefit that would normally cause the reduction. Again, your specific earnings history will determine if you can avoid this reduction by reporting slightly higher earnings than you may otherwise. Your competent CPA or Financial Planner can help make this determination.
I know this article did not include any numbers to show the trade-off I am describing, but that is due to the complexity of each individual case. The basic message here is to make sure you are not saving a few hundred or thousand dollars today while giving up tens of thousands in future lifetime Social Security benefits for you and your family. Please contact us if you think you may be exposed to this possibility and we can help you determine the trade offs.
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