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  • Writer's pictureChris Stein, CFP®

The Social Security Earnings Limit For Self Employed Individuals

A reader from Texas looks for clarification on the rules surrounding the Social Security earnings limit for self-employed people.

"My question is about the "earnings limit" for self-employed people. I'm retired at age 66 and will wait until 70 to collect my Social Security. My wife will be 62 in 2023 and is still working as a self-employed worker. After much analysis and discussion with our financial advisor, we have decided to turn on her Social Security benefits starting in early 2024. Her "net" self-employment income may go a bit over the earnings limit depending on the year. I am familiar with the rules about holding back $1 for every $2 over the earnings limit. We are OK with that since I know they will give her the credits back once at FRA. However, I recently heard a financial advisor mention that the earnings limit for self-employed people also includes a "significant work" clause. If I understand correctly, a self-employed person cannot work more than 45 hours per month and receive Social Security benefits unless at FRA or beyond. I reached out to my financial advisor, who reached out to her Social Security expert. She sent me links to the clause in the POMS, which I read. But again, not much detail around it. My financial advisor said that in 23 years, she has never run into this. There is no indication of how they collect this information to define how many hours per month a self-employed person works to determine eligibility. And, if I understand it correctly, the earnings test for a self-employed person is not determined until the following year when the IRS posts the earnings for the past year. In other words, if my wife starts collecting in 2024, Social Security won't know how much to withhold until early 2025, once 2024 taxes are in and posted. So when and how do they determine the number of hours worked per month? If you have any additional clarification on this aspect of the self-employed earnings test, specifically the 45-hour/month limit, I would appreciate it."

I will start at the end of your question because you made a comment that I need to clear up. You said that it won't be until 2025 that the Social Security Administration (SSA) will be able to apply 2024 earnings and maybe make a reduction. That's not quite how it works. When you claim and are not at your Full Retirement Age (FRA), they will ask you if you have expected earnings. They'll trust you at first. You'll say, "I think I'm going to make (fill in the blank)." They'll make any required reduction based on that information and then adjust once they get the official information. So the final adjustment won't occur until after they get the information from the IRS if you're an employee or from your tax return if you're self-employed. However, they'll have input from you from the outset.

It's a good idea to be upfront with them so they have the correct idea and you get the earnings test immediately. They're going to claw it back from you one way or another, and they'll do it quickly – rather than let you pay it as a reduction to your check every month. This process has nothing to do with whether you're self-employed or not; it applies to everybody.

Now, back to your core question. Yes, there's an earnings test. If you claim your retirement benefits before your FRA and you earn above a certain amount, they'll withhold $1 for every $2 that you earn over that amount for all the years leading up to your FRA. Then, the year you reach your FRA, the limit is much higher, and the offset is only $1 for every $3. That's basically what you're asking about. The earnings test exists because Social Security assumes you're retiring, just earning a little bit, yet you're still claiming. As a result, they just slightly reduce your Social Security benefit because of this earnings test.

For a self-employed individual, because Social Security knows you have control over the recognition of your income, they know you could play games. You could essentially keep working and not retire. You could present to the SSA that you're earning less than the earnings test and collect your Social Security benefit unreduced. (It would be reduced for collecting early, before reaching your FRA. However, it would not be further affected by the earnings test when you, in fact, kept working your job, self-employed in your own business.) That's why they apply this additional rule.

There's a certain amount of earning that would ultimately eliminate your benefit. A lot of self-employed people could be making enough to fall into that category. If your earnings are substantial, you may not be able to claim a benefit before FRA even if you wanted to because the earnings test would eliminate your Social Security benefit. They are avoiding game-playing.

So if you're self-employed, Social Security will first take what you tell them as the earnings you expect to have. But then, they will ask you essentially to prove through documentation that you are indeed retired and not providing substantial services to your own business. They define "substantial services" with a 45-hour time limit, but it's more nuanced than that.

If you work more than 45 hours, they won't consider those lower earnings you're claiming. Instead, they'll claim prior earnings that you have reported to them on your tax returns and use that for the earnings test, arguing you're not truly retired. They'll say, "We don't care what you're paying yourself now because you can play games with the numbers. We will use prior earnings as the owner of this business."

But it gets worse if your service to the business is considered highly skilled. However, there's no detailed description of what determines highly skilled. (It's likely up to the judgment of the Social Security people.)

If you're highly skilled, the limit is only 15 hours per month. If you work more than 15 hours in a highly skilled position, they will consider you not retired. Your wife will have to be wary of that, too. You didn't say what kind of work she is doing, but if it's considered by the SSA to be highly skilled, she will be limited to 15 hours per month to be considered truly retired. She may be totally fine, but I want to point that out.

When you're self-employed, Social Security will want you to prove that you're effectively retired. For example, it could be by showing that someone has taken over the activities you used to perform, by having family members assuming those duties, or by having a manager in place that takes care of stuff. Ultimately, you're a partially retired owner of the business that's just putting in a little time. That's what they're going to look for, and it will be up to their judgment. In short, it can be hard sometimes for self-employed individuals to fall outside of the punishments of the earnings test because of such issues.

This situation doesn't come up a lot. Our firm doesn't deal with many self-employed individuals, so I've only had a couple of such instances over the years. As I remember, both cases decided to throw up their hands and wait until their FRA to claim their benefits because they didn't have a great experience dealing with the SSA. I'm sure some advisors work with self-employed individuals as a niche. They may have run into this. I'd love for them to write me to provide more clarity based on their experience.

That's essentially the scope of your question. Remember, Social Security is trying to keep your wife from playing games with the numbers to keep her recognized income low enough to get a Social Security retirement benefit. Meanwhile, she's still an active participant in her own business. That's what they're looking for. If she can provide documentation that convinces them she's not doing that, she will probably be fine. But be aware that if it's a highly skilled activity that she's doing for the business, she only has a 15-hour per-month limit for them to consider, not a 45-hour limit.

In the end, it's up to Social Security to determine. They'll ask her for her information, and she'll have to present her material. Obviously, they don't have anyone who visits her business to check how many hours she's working. They're just going to ask for documentation that convinces them that she has genuinely reduced her work and that she's not contributing much to the business anymore.

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