What Impact Will an S Corp Have on Your Future Social Security Benefits? How S Corps Impact Future Social Security Benefits (2024)

One of the benefits of forming an S Corp is that it lets you take a portion of your business income as a distribution rather than through a paycheck, avoiding payroll taxes. However, payroll taxes are the primary way the United States funds Social Security, so it’s understandable to wonder how forming an S Corp could impact your retirement benefits.

If you’re considering electing to be an S Corp with the Internal Revenue Service (IRS) for tax purposes, here’s what you can expect regarding Social Security.

S Corps and payroll taxes

One key benefit of an S Corp business entity is that it helps shareholders mitigate some of the costs they incur due to self-employment tax. When you’re self-employed, the money you earn is treated as wages. Wages are subject to payroll taxes.

Typically, when you’re an employee, your employer pays half of your payroll taxes, and you, the employee, pay the other half. When you’re self-employed, you’re both the employer and employee, which means you pay taxes for both halves.

The payroll tax rate totals 15.3% on your first $160,200 of income in 2023. Of this amount, 12.4% is for Social Security and 2.9% for Medicare taxes. After your first $160,200, you will not be subject to Social Security but will still have to pay 2.9% for Medicare taxes.

If you form an S Corp, you typically pay yourself reasonable compensation, which is subject to FICA taxes, including Social Security and Medicare taxes. You can also take distributions from your company’s profits.

Distributions are business profit and are not considered self employment income. That means distributions are not subject to payroll taxes, so you save 15.3%. You’ll still pay regular federal income tax on the distribution portion. It’s important to note that avoiding the Social Security tax by taking advantage of distributions does reduce your future benefits. However, as we will discuss later, the reduction in benefits could be worth it.

The employer side of your self-employment taxes is also an allowable business expense, further reducing your federal income tax liability.

How Social Security benefits are calculated

Your Social Security benefit depends on a few factors, including the age at which you retire and when you choose to start taking your benefit. It also depends on how much money a retiree earns throughout their career.

Eligibility for Social Security benefits is contingent on accumulating at least 40 credits during your working career. You can earn a maximum of four credits per year, and credits are earned by making a nominal amount in wages. For 2023, you’ll earn one credit per $1,640 earned, meaning you must earn $6,560 overall to earn the maximum of four credits for the year.

Assuming you’re eligible for Social Security, your benefit is determined not by how much you earned in your last year of working but by the wages you received in the 35 years where you earned the most money. Each dollar you earn, up to the Social Security wage base, gets added to your lifetime earned income.

The Social Security Administration then finds your average monthly earnings during your 35 most lucrative years, with an adjustment for changes in national wage levels. This is your Average Indexed Monthly Earnings (AIME).

Your benefit, called your Primary Insurance Amount (PIA), is determined using a mathematical formula. This formula includes two income milestones called bend points. Income up to the first bend point ($1,115 in 2023) has a bigger impact on benefits than income between that first milestone and the second one ($6,721 in 2023). Income in excess of the second bend point has a negligible impact on benefits.

In short, as your earnings increase, the speed at which your benefit rises decreases.

The formula for calculating your PIA is:

90% of your AIME up to the first bend point + 32% of your AIME up to the second bend point + 15% of your AIME for income after the second bend point

Your PIA is then adjusted for factors like the age when you start taking the benefit.

How S Corps impact Social Security benefits

One key thing to note with these calculations regarding your benefit is that not all earnings count toward Social Security.

The Social Security Administration looks only at wages earned, not your overall income. Money you make working for an employer or that you pay yourself as a reasonable salary are wages and count toward your benefits. Things like investment income or distributions from your S Corp do not.

This means that the S Corp tax structure will reduce your Social Security benefit somewhat. Taking some of your company’s profits as distributions rather than wages means mitigating the payroll tax but also keeps that income from counting toward Social Security.

The good news is that most people will find the decrease in benefits to be negligible compared to the tax benefits of forming an S Corp.

For example, let’s say that Jane has a consulting business. It’s incredibly consistent, earning exactly $100,000 in profit in 2023. Her profits increase by precisely the rate of change in the national wage index each year. She works for 35 years before deciding to retire.

That leaves her with $3.5 million in earnings (in today’s money) that were subject to the Social Security tax. Her AIME, which consists of her average monthly earnings during her 35 most lucrative years, is $8,333.33.

Using the formula above, we can calculate that her PIA (or monthly benefit) will be:

(.9 x $1,115) + (.32 x ($6,721 – $1,115)) + (.15 x ( $8,333.33 – $6,721)) = $3,039.27

Assuming Jane takes Social Security benefits at full retirement age (FRA), she’ll get the full benefit of $3,039.27 per month in Social Security income.

Now, imagine she chose to form an S Corp at the beginning of her career. She pays herself a reasonable compensation of $60,000 per year, taking the remaining $40,000 in profit as a distribution.

Her new AIME is $5,000, resulting in a PIA of:

(.9 x $1,115) + (.32 x ($5,000 – $1,115) = $2,246.70

Jane’s monthly benefit is $792.57 smaller. However, she lowered her payroll tax liability by 15.3% on $40,000 of income each year for 35 years, which is a total savings of $214,200. It would take a little more than 22 years of the higher Social Security benefit to receive more than she would save through her S Corp.

Given how bend points work when calculating Social Security benefits, the benefit of an S Corp is even more pronounced for higher earners because the reduction in benefit will be smaller.

What S Corp owners can do to prepare for retirement

If you decide to form an S Corp, there’s a possibility that it will impact your future Social Security benefits. Distributions aren’t subject to Social Security tax. However, they don’t count toward your future benefit, lowering how much you’ll receive in retirement.

So, what can you do about this?

The first option is simply not to worry. The greatest benefit of Social Security comes from income up to the first bend point, which is set at $1,115 in monthly wages for 2023. The returns diminish significantly after that.

The amount you can save in taxes by forming an S Corp is large compared to the reduction in your future benefits. Considering that a dollar today is worth more than one tomorrow (or in 35 or 40 years), you’re likely better off taking advantage despite the reduction in future benefits.

If you’re still worried about your retirement plan, a great thing to do is to put some of the money you saved on payroll taxes into a retirement account. A Solo 401(k), SEP IRA, or insurance contract like an annuity allows you to build a nest egg for retirement. It could easily provide an income stream similar to or greater than Social Security.

Final word

Forming an S Corp and taking some of your earnings as a distribution rather than wages will reduce your taxable income and future Social Security benefits, but you do not need to worry. The impact of lower tax payments will be relatively small compared to your tax savings. Plus, you can easily offset the lower benefit with increased retirement savings funded through the tax savings that distributions provide small business owners.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or financial advice. You should consult your own legal and financial advisors to determine the the legal setup of your business.

What Impact Will an S Corp Have on Your Future Social Security Benefits? How S Corps Impact Future Social Security Benefits (1)

T.J. Porter

TJ Porter is a freelance writer based in Boston, Massachusetts. He began covering finance while earning a degree in business at Northeastern University in Boston, Massachusetts and enjoys writing about credit, investing, real estate topics. When he’s not writing, TJ enjoys cooking, sports, and games of the video and board varieties. You can contact him at find more of his work at TJPorterWriting.com

What Impact Will an S Corp Have on Your Future Social Security Benefits? How S Corps Impact Future Social Security Benefits (2024)

FAQs

What Impact Will an S Corp Have on Your Future Social Security Benefits? How S Corps Impact Future Social Security Benefits? ›

Forming an S Corp and taking some of your earnings as a distribution rather than wages will reduce your taxable income and future Social Security benefits, but you do not need to worry. The impact of lower tax payments will be relatively small compared to your tax savings.

What is the benefit of an S corporation? ›

One major advantage of an S corporation is that it provides owners limited liability protection, regardless of its tax status. Limited liability protection means that the owners' personal assets are shielded from the claims of business creditors—whether the claims arise from contracts or litigation.

Do corporations contribute to Social Security? ›

Social Security is financed through a dedicated payroll tax. Employers and employees each pay 6.2 percent of wages up to the taxable maximum of $168,600 (in 2024), while the self-employed pay 12.4 percent.

How does company pension affect Social Security? ›

For Retirement and Disability benefits

Your Social Security benefit might be reduced if you get a pension from an employer who wasn't required to withhold Social Security taxes. This reduction is called the “Windfall Elimination Provision” (WEP). It most commonly affects government work or work in other countries.

How does self-employment affect Social Security benefits? ›

Self-employed workers must pay both the employee and employer portions of Social Security taxes. Reducing your income by taking every available deduction will reduce your taxes, but it will also reduce the size of your Social Security benefit payment in retirement.

What are an S corporations pros and cons? ›

Is an S-Corp Right for Me?
S-Corp AdvantagesS-Corp Disadvantages
Limited liability for directors, officers and shareholders.Can only have one class of stock.
Independent life from shareholders.Harder to raise equity financing than C-corps.
4 more rows
Dec 14, 2022

What happens when an S corp has a loss? ›

In a situation where an S corporation loses money, the same accounting occurs. If an S corporation with two equal shareholders loses $200,000, each shareholder reports a $100,000 loss from the S corporation on his or her personal return.

How does an S Corp affect Social Security benefits? ›

The Social Security Administration looks only at wages earned, not your overall income. Money you make working for an employer or that you pay yourself as a reasonable salary are wages and count toward your benefits. Things like investment income or distributions from your S Corp do not.

How does owning a business affect my Social Security benefits? ›

We use all your earnings covered by Social Security to figure your Social Security benefit. Be sure to report all earnings up to the maximum, as required by law. Net earnings for Social Security are your gross earnings from your trade or business, minus your allowable business deductions and depreciation.

Why do companies need Social Security? ›

Many businesses will ask for your Social Security number simply because it's a convenient way for them to identify customers. Unfortunately, criminals can use your Social Security number to commit identity theft, so you should guard your SSN carefully and only give it out when absolutely necessary.

What affects Social Security retirement benefits? ›

If there were some years you didn't work or had low earnings, your benefit amount may be lower than if you had worked steadily. The age at which you decide to retire also affects your benefit. If you retire at age 62, the earliest possible Social Security retirement age, your benefit will be lower than if you wait.

What would cause my Social Security benefits to decrease? ›

We'll have to reduce your benefits, however, if your earnings exceed certain limits for the months before you reach your full retirement age. If you work, but start receiving benefits before full retirement age, we deduct $1 in benefits for every $2 in earnings you have above the annual limit.

What reduces Social Security benefits? ›

If you are younger than full retirement age and earn more than the yearly earnings limit, we may reduce your benefit amount.

At what age is Social Security no longer taxed? ›

Social Security can potentially be subject to tax regardless of your age. While you may have heard at some point that Social Security is no longer taxable after 70 or some other age, this isn't the case. In reality, Social Security is taxed at any age if your income exceeds a certain level.

How does employment affect Social Security benefits? ›

You can get Social Security retirement benefits and work at the same time. However, if you are younger than full retirement age and make more than the yearly earnings limit, we will reduce your benefits. Starting with the month you reach full retirement age, we will not reduce your benefits no matter how much you earn.

What is the maximum Social Security benefit? ›

The maximum Social Security check

Your maximum benefit if you file at full retirement age – between 66 and 67 – is $3,822 per month. Your maximum benefit if you file at age 70 – the age when extra benefits stop accruing – is $4,873 per month.

Is it better to have an LLC or S corp? ›

Choosing an S-corp will help you save on your self-employment taxes, just be aware that this will require intense and precise bookkeeping. LLCs are best suited for smaller businesses because of their flexibility, cost and convenience. LLCs require far less paperwork to both create and maintain than an S-corp.

What are the benefits of an S vs C Corp? ›

Single layer of taxation: The main advantage of the S corp over the C corp is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level.

How does an S corp save on taxes? ›

There's no employment tax on S Corp distributions

A distribution is earnings and profits that pass through the business to you the owner. Basically it's what you earn outside of your employee wages. So, the larger your distribution, the less employment tax you'll pay.

How does an S corp avoid double taxation? ›

Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.

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