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    Can I save social security tax in my business?

    Yes there are a several ways. However, many people want to pay as much social security tax as is necessary to insure themselves that they or their heirs will qualify for the following social security benefits:

    • Retirement
    • Disability
    • Survivors

    Having said that, it is quite common for individuals to pay more social security tax than income tax. After all, the social security rate for employees is 7.65% on the first $97,500 of earned income in 2007 and 1.45% on all earned income above $97,500. Employers must match that amount. Generally, if you are self- employed you pay about double the employee rate, but because of the calculation the actual tax is not quite that amount.

    How can I save social security tax in my business?

    • Hire your child under the age of 18 to work in your business.

    Wages paid to dependent children under 18 years of age are not subject to social security tax. But make certain your boy or girl can legally work for you and that any and all state payroll taxes are properly paid.

    • Reimburse your spouse under a qualified medical reimbursement plan.

    Medical reimbursements paid to your spouse under a qualified Internal Revenue Code section 105 medical reimbursement plan are deductible as a business expense and therefore will reduce your social security tax.
    Note: These plans are more fully covered in a related article.

    • Form an S corporation

    As a sole- proprietor you are paying social security tax on all of your net income. By converting your business to an "S" corporation it is possible to avoid social security tax on some of your income by taking out distributions of profit. You only have to pay social security tax on the reasonable wages and not the distributions.

    Example: Assume your sole proprietorship has net income of $80,000. Currently, the entire $80,000 is subject to social security and medicare tax. But let's say you formed an S corporation and took out wages of $20,000 and $60,000 in distributions. You would only have to pay social security tax on the $20,000. The savings in social security tax (6.20%) and medicare tax (1.45%) [including the company's matching] would be about $9,180 {$60,000 @ 15.3%).

    *It is important that you pay yourself a reasonable wage. The IRS is aware that taxpayers form S corporations to play " Beat the social security tax game". If you don't pay a reasonable wage, the IRS may recharacterize all of the distributions as wages, and make you pay social security tax on all you have taken out of the corporation, plus back interest and penalties. [Note: in court cases the IRS has recharacterized distributions only when the "S" Corp. pays no compensation to their respective shareholders or officers].

    *Your retirement plan contributions may be lower. This is because your retirement plan contributions are based on your earned income. Since your earned income is reduced, the amount you can put away for retirement may also be reduced. The net effect is that while your social security tax may be lower, you could be paying higher income tax due to the reduced deductions for retirement. However, the retirement will eventually be taxable when you take out your retirement funds and perhaps at a higher marginal tax rate that you are currently experiencing. Additionally, the "S" Corp. could set up a Simple IRA Retirement Plan (Salary Reduction), which allows you (the shareholder/officer) to put up to $6,000 into the Simple. Hence, if the Shareholder contributed $6,000 into a Simple IRA and was paid an annual Salary of $20,000 - his, or her, W-2 would reflect $14,000 in taxable wages ($20,000 less the $6,000).

    • Rent property from your spouse

    Your spouse does not have to pay social security tax on rents received from you for a building or other real property you rent for your business. There is no income tax savings because any rent expense you deduct on your business must be included as rental income for your spouse. However there is social security tax savings. Care must be exercised if you are structuring this arrangement under community property laws.

    There are several ways to cut social security taxes in your small business. But before doing so you must look at all of the factors.

    Return to Individual Tax Planning


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