Paying FICA as a Small Business Owner: Social Security & Medicare

As a small business owner, you probably the know the pain of handing over a large tax bill every quarter. One large expense that small business owners pay, but employees rarely think of, is the Federal Insurance Contributions Act (FICA)...

As a small business owner, you probably the know the pain of handing over a large tax bill every quarter. One large expense that small business owners pay, but employees rarely think of, is the Federal Insurance Contributions Act (FICA) tax.

Self-employed persons aren’t exempt. They pay a comparable tax through the Self-Employment Contributions Act (SECA). For 2015, the tax is comprised of a 12.4% tax split between employee and employer up to a salary of $118,500 for Social Security, and a 1.45-2.35% tax for Medicare.  

Paying FICA Tax

FICA and SECA taxes fund the Social Security and Medicare programs. Medicare provides health care subsidies for taxpayers who are aged 65 or older or are disabled. Social Security provides retirement income, disability income, Medicaid, and death and survivorship benefits.

Paying this tax will ensure that you have some amount of income in your old age or if you become disabled. And if you were to pass away unexpectedly, any minor children also will receive some amount of financial support.

The Future of Social Security and Medicare

Many Americans rely on Social Security and Medicare in their retirement. But as you probably know, a large number of Americans will be entering retirement, and Americans are living much longer as compared to previous generations.

This does present a funding shortfall with current guidelines. Knowing that, can you rely on Social Security and Medicare to be there when you retire?  

There’s no doubt that the rules of Social Security and Medicare will be modified over time. According to the Social Security Trustees’ report, the trust is expected to be depleted in 2035, and then pay around 79% of previous benefits. The Medicare Trustees’ report expects the fund to last until at least 2030.

But for someone in their mid-thirties, Social Security and Medicare should exist in some form in thirty or so years. Even if the benefit is reduced, we can expect some amount of financial and health-care support in retirement.

A Closer Look at the Social Security Benefit

According to current guidelines, what benefit would you receive in retirement? How does the Social Security Benefit work?

The Social Security benefit is calculated off of the the 35 years in your working career where you earned the highest salary. If you earned more the Social Security maximum earnings level ($118,500 for 2015), the maximum earnings level is used instead of your actual income in the calculation.

This number is then adjusted for inflation, and then divided by the number of months (420) to create a monthly salary. This actual benefit is calculated from this salary number, consisting of 90% of the first $826 dollars, 32% of the next dollars up to $4,154, and 15% of the remaining dollars.

Say you’re 35, and you plan to hit the Social Security maximum earning level every year of your entire career starting at age 22 until you retire at the age of 67. Assuming the current Social Security maximum earning level rises  with inflation but sees no further increase, you’d take home $2,847 in retirement every month at age 67. It takes until the age of 86.5 before you earn back every dollar you paid in Social Security.

If you’re interested in your exact benefit, explore the Social Security Retirement Estimator and the request your personal Social Security Statement. Also, if you are a government worker with a pension, your pension will adjust your Social Security according to the Windfall Elimination Provision.

Making the Most of Social Security and Your Retirement

If you’d been able to invest that money at a rate of 6% annually, instead of paying into Social Security, you’d have about 3x the monthly benefit ($10,770) to live off of every month. After all, you don’t get to keep 100% of what you pay in.

If you can minimize your FICA tax, and then actually invest the difference, you’ll end up with more money in your retirement.

If you are a business owner with an S-Corporation or an LLC filing as an S-Corporation, it’s possible to reduce the amount of FICA tax you have to pay. By paying yourself a reasonable salary from the corporation, you’ll pay FICA tax on your salary, but not the rest of the earnings of the business. The net profit of the business is subject to ordinary income tax.

Since paying Social Security isn’t optional, you might as well make the most of your benefit. You and your spouse can work together to space out your benefits so you’ll receive the most money during your lifetimes.

As a business owner, paying FICA tax is unavoidable. By understanding how your Social Security benefit works, you can pay less in FICA tax, while maximizing your Social Security benefit and your retirement nest egg.