How Self-Employment Tax Impacts Your Social Security Benefits in Retirement

If you’re a business owner, freelancer, or independent contractor, you’ve probably seen the buzz on social media: “Form an S-Corporation and avoid self-employment tax!” Strategists and influencers across YouTube, TikTok, and Instagram often pitch the S-Corp as the ultimate move to save thousands in taxes.

But is it really that simple? And what are the long-term consequences—especially for your Social Security benefits in retirement?

This post explains how self-employment income and self-employment tax affect your future Social Security benefits, why the S-Corp strategy isn’t one-size-fits-all, and what to consider if you want to maximize retirement income. We’ll also address common Social Security myths that can cost you peace of mind—and money.

The S-Corp Hype: What Social Media Gets Right (and Wrong)

Here’s the logic you’ll often hear:

• Sole proprietors and single-member LLCs pay self-employment tax (15.3%) on all net business income.
• S-Corporation owners can split income into a “reasonable salary” (subject to payroll taxes) and “distributions” (not subject to self-employment tax).

This can save thousands as your business grows. It’s a legitimate strategy—and for many, it makes sense. But what’s often left out: self-employment tax isn’t just a burden; it’s also an investment in your future Social Security benefits.

Self-Employment Tax: The Double-Edged Sword

Self-employment tax has two parts: 12.4% for Social Security and 2.9% for Medicare. Employees split these with their employers; as a self-employed person, you pay both halves.

Key point: The more you pay into Social Security through self-employment tax, the higher your potential Social Security benefit in retirement.

How Social Security Benefits Are Calculated

The Social Security Administration (SSA) uses your highest 35 years of earnings to determine your monthly benefit:

1. SSA indexes your annual earnings for changes in average wages over time.
2. They select your 35 highest-earning years (inflation-adjusted).
3. They average those years to get your Average Indexed Monthly Earnings (AIME).
4. They apply a formula to your AIME to calculate your Primary Insurance Amount (PIA)—the monthly benefit at your Full Retirement Age (FRA).

If you have fewer than 35 years of earnings, zeros are averaged in, which reduces your benefit. Self-employment income reported on your tax return (Schedule SE) counts in this calculation—but only if you actually pay self-employment tax on it. If you shift most income to S-Corp distributions to avoid self-employment tax, you reduce the amount of income that counts toward your Social Security record.

The S-Corp Tradeoff: Lower Taxes Now, Lower Benefits Later

Example:

• Sole Proprietor: Earns $100,000 net income and pays self-employment tax on the full amount. All $100,000 counts toward Social Security.
• S-Corp Owner: Pays a $40,000 salary (subject to payroll tax) and takes $60,000 as distributions (not subject to self-employment tax). Only $40,000 counts toward Social Security.

Result: The S-Corp owner saves on taxes now, but their future Social Security benefit is based on a much lower income. For some, that’s a worthwhile tradeoff. For others—especially those who plan to rely on Social Security—it could be a costly mistake.

Timing Matters: When You Claim Social Security

Your benefit depends on your earnings record and the age you claim:

• Full Retirement Age (FRA): For most people born after 1960, FRA is 67.
• Claiming before FRA: You can start as early as 62, but your benefit is reduced by about 6% for each year you claim early. At 62, you receive roughly 70% of your full benefit.
• Claiming after FRA: For each year you delay past 67 (up to 70), your benefit increases by about 8% per year (delayed retirement credits).
• Cost of Living Adjustment (COLA): Benefits are adjusted annually for inflation, but your base benefit is set by your earnings record and claiming age.

Planning Strategies for Business Owners

1. Balance tax savings with retirement needs. If you’re considering an S-Corp, run the numbers. How much do you save now? How much might you lose in future Social Security benefits? If you have other retirement savings (a 401(k), an IRA, or a brokerage account), a lower Social Security benefit may be acceptable. If not, consider paying yourself a higher salary to support your future benefits.
2. Maximize your 35 highest-earning years. If you have low- or no-earning years, increasing reported self-employment income (and tax paid) in later years can replace zeros and raise your benefit.
3. Plan your claiming age. Delaying Social Security can significantly increase your monthly benefit. If you can wait until 67—or even 70—you’ll receive a larger payment for life.
4. Consult a professional. Social Security planning is complex, especially for business owners. Coordinate tax strategy and retirement planning with a professional who understands both.

MythBusters: The Truth About Social Security

Myth #1: “Social Security is bankrupt.” The Social Security Trust Fund is projected to be depleted in the 2030s, but ongoing payroll taxes would still fund about 75–80% of promised benefits. Congress is likely to make changes to shore up the system. Social Security isn’t going away—it’s facing challenges that require policy decisions.

Myth #2: “Income taxes fund Social Security.” Social Security is funded primarily through payroll taxes—the same self-employment and FICA payroll taxes paid by workers and employers. Income taxes play only a minor role (mainly from the taxation of Social Security benefits for higher-income retirees). Today’s contributions fund current retirees; future workers will fund yours.

The Bottom Line

Self-employment tax isn’t just a bill—it’s an investment in your future Social Security benefits. S-Corp strategies can save money now, but they can also reduce lifetime benefits later. The “right” choice depends on your earnings profile, retirement goals, and overall plan.

Don’t let social media shortcuts cost you in the long run. Understand how business decisions today affect financial security tomorrow. Run the numbers, document your approach, and work with professionals to make informed choices.

Questions about self-employment, S-Corps, or Social Security? Reach out to our team for a personalized review of your situation.

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