Q&A - How can you avoid the Social Security earnings test, and minimize taxes using an S-corp?
Question
How can you avoid the Social Security earnings test, and minimize taxes using an S-corp?
Answer
Using an S corp may provide at least two benefits:
- Avoiding FICA tax (15.3%)
- Avoiding the earnings test
Here’s an example that illustrates the combined FICA tax benefits and earnings test benefits of S-Corp:
Mr. X has expressed an interest in establishing his own consulting business after retiring from federal service.
If Mr. x receives business revenue, depending on the amount of revenue, it may make sense to incorporate his business. For example, assuming business income is $50k and business expenses are $20k. In such a case the business would net $30k of profits.
From a tax perspective, you can claim all $30k as individual income, however doing so will subject the entire $30k to FICA taxation (15.3% in 2023). This translates into about $4,590 of FICA tax. This $30k will also be counted as earned income and will reduce Mr. X’s Social Security by about $4,500 (2023).
An alternate route may be to structure the income as S-corp income. The S-corp income would be paid to Mr. X in 2 forms:
- As an employee of the S-corp. This would be considered wages and subject to the above FICA tax rates. This would also be considered earned income and subject to the Social security earnings test.
- As a shareholder of the S-corp. This would not be considered wages and thus not subject to the above FICA tax rates. In addition, this would not be considered earned income and thus not subject to the Social security earnings test.
If you use an S corp structure, some of the $30k will need to paid as wages. Assuming 50% of the profits will be treated as wages, that means $15k will be wages, which is less than the earnings test threshold of $21,240 (2023). The wages will be subject to a $2,295 FICA tax, but anything beyond the wages will not be subject to FICA, and not be subject to the earnings test.
The $2,295 of tax savings + avoiding the earning test reduction of $4,500 translates into about $6,795k of total savings, minus, of course, the accountant’s fees.
