 Personal Finance PowerPoint Presentation Social Security and the self-employed. Prepare to get financially fit by practicing personal finance. In prior sections, we've talked about investment goals, strategies, tools, now honing down to the specific goal of retirement planning, first listing out the types of income we might have available in the retirement years, including employer pension plans. I'm including the 401k plans here as well. We've talked about them in the past. Public pension plans, which I'm going to include the 403Bs in this category as well. And we can think about them as similar to the employer pension plans, but for those working in the public sector for the government, for example, I'm also going to include in this public category benefit programs such as Social Security, which we are focusing in on at this time. We've got the personal retirement plans, things like possibly an IRA or other investments that are for retirement available then at retirement annuities, a specific investment vehicle we might talk about more in future presentations. Most of this information comes from Investopedia, how Social Security works for self-employed. So we're focusing in on the self-employed component of it because that can have some implications in terms of our planning, for example, and how we're accumulating the payments that are going into, for example, the benefit program, and that will have an impact on the payments, of course, that will be paid out in retirement. This by Amy Fontenier updated April 7, 2022. Now as we think about the Social Security, there's two sides of the coin we're usually talking about. Either us putting money in and usually in the form of payroll taxes, however, if self-employed, now we have the self-employment tax, and then we have us taking the money out in terms of the benefits that we're going to be receiving. We're focused in on taking the money out, but that's going to be impacted how much we're going to get on how much money we're putting in as well. And so when we think about the self-employment, we've got to consider how the money is going to be accumulated and how it's going to impact the payments that we're going to be receiving. If we're getting close to the retirement years, then we might want to, of course, think about how we might maximize the amount of benefit that we might have at the point of retirement. Keeping that in mind, how Social Security works for self-employed. When you work for someone else, that employer takes Social Security tax out of your paycheck and sends the money to the internal revenue service. So you get taxed when you're an employee, you have W-2 employee, when you get paid, they take money out, they pay it for income taxes, but they also break out the Social Security as a part of your paycheck and they give that to the government as well. So it's different kind of forms of taxes, even though they're both kind of federal income taxes because in theory, they're going to different accounts on the government side of things. But things work a little differently for people who are self-employed. If you fall into this category, keep reading. This article will help you understand how to calculate the Social Security taxes you owe. Now, notice that on the employer side, just something to point out, is that it's kind of, they tried to set it up when they put this together like a matching kind of plan for a 401K plan, even though it's different, but that's kind of the set up on its facade or its face at least, because you're going to put money in and then the employer matches money. Therefore, they have to pay payroll taxes too. So now when you're self-employed, the government still wants to get that payroll tax now called self-employment tax, but now you're basically the employer and the employee side of things. So that kind of complicates things a little bit, makes it a little different at least. Understanding Social Security taxes. If you work for someone else, Social Security taxes are deducted from your paycheck. The Social Security tax rate for 2022 is 6.2% plus 1.45% for Medicare taxes. So what goes under the category of quote, payroll taxes, end quote, includes the Social Security that takes out of your paycheck, your half of it is 6.2% at this point, plus you've got to pay Medicare, which is the 1.45. We're focused here on generally the Social Security side of things. So and remember when we pay into Social Security, that's a fairly large percent, 6.2, and the employer is paying their half as well that's going into it. And that's why Social Security more and more these days is being thought of not as a safety net or welfare program as much for people that need it, but it's almost thought of as you can depend on it no matter how much income you have because it's a pretty significant tax. And that's kind of a shift in thinking with some of these programs, which originally were thought of more as a welfare program for people that need them. Now they're thought of as almost like a government retirement plan that we can all depend on no matter how much income we have. And the amount of tax being taken kind of shows that to some degree. So if your annual salary is $147,000, the amount that will go to Social Security in 2022 over the year is $9,114. This amount represents the most an individual pay in Social Security taxes. In other words, there's a cap on the Social Security tax. It's kind of like a flat tax at 6.2% one rate instead of multiple rates, like a progressive tax on income taxes. And it's capped at $147,000, which seems weird. You might say, well, that's weird because if I make more money, you're not going to tax me. And that's kind of because we no longer really we don't really think of it as just a welfare program. It's kind of we're paying into the system expecting something in return. And there's no benefit that we're going to get on the taxation for the benefit side of things after we hit the threshold of $147,000. Therefore, you stop paying Social Security taxes at the threshold. So your employer will match that amount over the year. And it will also report their Social Security wages to the government. So you can think of it kind of like a 401k matching plan in that case, even though Social Security is different in other ways than that. But that matching thing is what they try to mirror. So when you retire or become disabled, the government uses your history of Social Security wages and tax credits to calculate the benefit payment you'll receive. So your payment will be dependent in part on how much you paid into the system. The more you paid in, the more you'll get in benefits. Although the higher dollar amounts, you'll get less of a benefit as you get the higher dollar amount. So it's still kind of catered towards somewhat of a welfare program as opposed to like a retirement plan in that way. OK, so what happens when you're self-employed? When you're self-employed, you're considered both the employee and the employer. So the IRS, your sole proprietorship, they're going to say, hey, you're both the employee and the employer for payroll taxes. And they're going to hit you on both sides for the employee and employer portion. This means it's your responsibility to withhold Social Security from your earnings contributing the employer's portion of Social Security as well as the individual's portion. Instead of withholding Social Security taxes from each paycheck, many self-employed people don't get regular paychecks. Because if you have a schedule C, then you're not going to pay yourself a paycheck. If you're an S corporation, you may have to. That's kind of why maybe some people set up as a single member S corporation in order to try to reduce payroll taxes, maybe. But sole proprietor, you're not going to pay your wages to yourself possibly. So you pay all the Social Security taxes on your earnings when you file your annual federal income tax return, meaning your net income on schedule C is what's going to be subject to payroll taxes as well as federal income taxes in general. So this amounts to both your contributions and your business contributions. So then you're going to get hit with self-employment tax, which is the equivalent of payroll taxes in essence, but you're going to get hit in essence with twice the rate, basically, because you're now the employer and employee. So IRS Schedule SE, self-employment tax, is where you report your business net profit or loss as calculated on schedule C. The federal government uses this information to calculate the Social Security benefits you'll be entitled to later on down the road. Self-employment tax consists of both the employee and employer portion of Social Security. So that's the 6.2 employee plus 6.2 employer. That's the 12.4% rate that's paid, which is getting quite high. And the employee and employer portion of Medicare is 1.45 plus 1.45, which is now 2.9%. So you've got the 12.4 plus 2.9, which makes the total self-employment tax 15.3%. This is getting ridiculous. So it may seem like you're getting the short end of the stick because you have to pay both employee and employer portion of it. It sure does seem like that, but that isn't necessarily true. Are you sure? It feels true. I don't want to pay 15%. Anyway, self-employed tax deductions. If you are self-employed, how much you pay in Social Security taxes is based on your net income. So if you're thinking like if you have an option of being a W-2 employee or self-employed, a lot of times the IRS tries to make it so it's not an option as if there's a clear line between self-employed and not self-employed. But sometimes it's kind of a gray area. Do you want to be a contractor or are you going to try to work specifically as a W-2 employee? You would think then, just looking at this, it would be better to be an employee because then you'd only be paying 6.2% instead of the 12 or whatever. But that's not necessarily the case because if you're a contractor, you get to deduct all the stuff. So if you have a lot of expenses that you're paying yourself for, then you might have more capacity to deduct them and you're only being taxed at the net income, not the gross income. So on Schedule SE, you multiply your business net profit or loss as calculated on Schedule C by 92.35% before calculating how much self-employed tax you owe. So there's a little bit more of a wrinkle than just taking the net income. You also got this 92.35, which I'm not sure exactly where they came up with that. Like, why does it 92.35? Like, everything else we've done thus far makes sense even if you don't agree with it. But you got that. That's a little wrinkle to it. So if your Schedule C profit were 100,000, you'd only pay 12.4% combined employee or portion of social security tax on 92,350. Oh, well, that's a little better, I guess. Instead of paying $12,400, you'd pay $11,451. That's still a lot of money. So this tax deduction would save you $948.960. That still seems high. Half of $11,451.40 is $5,725.70, representing the employer's matching portion of the social security tax. It's considered a business expense and reduces your tax liability. So in other words, now you've got this situation where the IRS is saying, on the Schedule C, we're going to treat you like you're the employer and the employee. Charge you double, except we're going to give you this little tweak. So we're going to lower it a little bit. But then you might say, but if I was an employer, I'd get to deduct half of the taxes on my income taxes as the employer. And I'm not deducting that here. And I can't deduct it on the Schedule C because this is calculated based on the net income on the Schedule C. So you get an above the line deduction for the employer portion of the tax. So it's all, it's quite confusing from a tax standpoint to fail out the tax return. But that's the general idea. So you report it online 14 of the Schedule 1, additional income and adjustments to income, and subtract it from line six of page two, a form 1040 marked total income. This business expense would reduce your taxable earnings to $94,274.30, which you enter online seven or adjust to gross income. Okay, so your total amount of self-employment tax $11,451.40 is reported online four of Schedule 2, additional tax, you then report any other taxes. There are eight categories on the same form, total them all and list that total online 10 in our example. There are no other taxes, so that amount is still $11,451. So this is then entered online 15 of page two, a form 1040 marked other taxes, including self-employment tax from Schedule 2, line 10. Of course, you also have to pay regular income taxes, cuz this is the self-employment side of things. How minimizing taxes minimizes benefits. Besides the social security tax deductions you can take when you're self-employed, many business expenses can reduce your tax liability. So if you're self-employed, you're more likely to be able to take deductions than if you're a W-2 employee lowering the net income, which not only lowers the federal income taxes but possibly the social security taxes as well, which is great. However, lowering the amount of taxes you pay can have an impact of lowering the benefits that you would get in the calculation in the retirement years. It's usually what you wanna do because usually lower taxes or the taxes that you would be paying if not lowered would be higher than the benefit that you would be getting. However, you wanna keep that in mind. You also wanna keep in mind that if you have a spouse involved in the business or connected in some way as well, that you're thinking about how the social security is being allocated between the spouses involved. Because the social security tax is not applied to one entity as kind of like the income tax is to some degree, right? The income tax is applied to a marital entity. Whereas the social security tax is applied to the individual, although there's some commingling in the kind of benefits that you can get. So you wanna think about who's being allocated the social security income, even if it doesn't have an overall impact on the taxes being paid that year because it could have an impact on the benefits that are gonna be calculated. Okay, quote, business expenses reduce your overall tax, which ultimately lowers your social security taxes. Business tax deductions are a way of minimizing self-employment tax and social security taxes, in quote says Carlos Dio's Jr. founder and manager partner of Dio's Wealth LLC. So, but keep in mind that this can work against you regarding social security benefit calculations, which are based in part on your taxable earnings. So if you lower the social security taxes you're paying, then you might be lowering the benefits that you're gonna be getting. Again, that's usually still what you wanna do, but you wanna keep that in mind. Here's why. The more deductions you have, the lower your Schedule C income. Lowering your Schedule C income is a good way to reduce how much federal, state, and local income tax you owe. However, this lower amount becomes part of your social security earnings, history, and means you may receive lower benefits in retirement than if you didn't take those deductions. Minimize taxes now or maximize benefits later. So then the question comes in, should I try to be maximizing my benefits or should I be minimizing my taxes at this point in time? I would think that generally you would want to minimize the taxes at this point in time in general because you're probably getting more of a savings in general anyways. And I personally would not want to be dependent upon the social security keeping their promise going forward given the fact that it's basically bankrupt at this point in time anyway. So I would think that the further away you are towards retirement, the less faith I have in the social security being around in the same format that it is now. I might have to be 102 before I start collecting or something. But in any case, maybe that's just me being skeptical. So should you skip some or all of the business tax deductions you're entitled to increase your future social security benefit? Maybe the answer is complicated because lower earning business people stand to gain more in the future than their higher earning counterparts due to how social security retirement benefits are calculated. In other words, really to get into the weeds on this calculation, we'd have to think of how social security is being calculated and think about how an increase in our income would impact the taxes. So the way the system generally works is as you increase your income, you're getting less and less of a benefit from that increase in income. That's why it's still kind of somewhat like a welfare program. It's kind of like a progressive tax in that way you might call it. So if you have a lot of high income years, then the added benefit that you're going to get is probably going to be less because you're going to get less of a benefit from that higher income. But if you have low income, then increase in the amount that you pay a little bit may have a significant impact on the calculation in retirement. And you also might think about that in terms of a spousal benefit, which can get a little bit confusing as well if they're connected or working as well. So in any case, another critical factor is where your schedule C earnings fall compared to your previous year's earnings. So if you have a full 35-year career behind you and you're not earning nearly as much in your current self-employed pursuits, it makes sense to take all the deductions you can as your social security benefits will be calculated based on your 35 highest earning years. So in other words, if you've worked 35 years and now you're working self-employed and the 35 working years, you are making more money than you're currently making at this point in time, then those are the years that are going to be taken into consideration. And you want to consider time value of money involved in that. So if you time value the money in those early years, it's going to be higher or more comparable to the current years. Then, of course, you would want the deductions at this point in time because these years probably aren't going to have an impact at all on your calculations if you have 35 years of higher income. So in this case, you want to minimize your social security taxes. But if you're currently in the high earning part of your career, a higher schedule C income can help you get higher social security benefits later. So unless you enjoy complex math problems or have a top-notch accountant, it's probably not worth the headache to figure out whether you'll earn more in future social security benefits than you'd save by claiming all the deductions you can today. Of course, suppose you're on the cusp of not having enough schedule C income to give you the work credits you need to qualify for social security. In that case, it may be worth foregoing some deductions to make sure you're entitled to any benefits at all. So you want to make sure you're clearing the threshold of benefits if you can at the minimum, possibly. How much control do you want? So as we don't know what social security benefit payments will look like in the future, many people expect them to be lower because of how the system is funded. So in other words, if you're further away from receiving social security, the law could totally change and you would expect it to increase the age of social security and possibly lower the benefits given the fact that social security is kind of bankrupt at this point in time. So you want to keep that into consideration. So you may want to go with the sure thing and take the lower tax liability today. So if you're further away from retirement, then I would take the tax benefit if you could earlier generally. After all, one way to lower your tax liability is to take money out of your business and put it in one of the available retirement plans for self-employed. So you could put it into an IRA or different kind of self-employment plans or simple or something like that. So that's money you'll have a lot more control over than social security benefits. Quote, the great thing about social security is you cannot access it until retirement age. End quote says Kevin Michaels, CFPEA financial planner. Quote, you can't make early withdrawals. But you can't skip payments and you are guaranteed a benefit. End quote Michaels adds quote. However, you have only a small say in the future legislation of social security and how it will be affected by the mis by the mismanagement of government funds. So most people would agree that the social security funds might not be ideally managed, right? Which could lead to problems at some point in the future, you would think. Michaels continues to say the following. If you have trouble saving for retirement already, then paying as much as allowed into social security may be the better option. I wouldn't think, I don't personally really agree with that. The idea that you're going to put money into social security and it's a good thing that's locked away and you can't touch it under any circumstances. To me, that doesn't seem like a good thing. He's basically saying if you have a problem saving money, it's better to be able to lock it away and not be able to touch it would be the idea. But I think there's other ways to deal with that problem than that. But in any case, if you are confident you can stick to a savings plan, invest wisely and not touch your savings until retirement. It may be a better idea to minimize what you pay into social security and take more responsibility for your retirement. That seems like the better option to me. Take more responsibility for it. So if you fail to file, if you don't file a tax return report in your self-employment income, you have a limited time to file a return and still get credit worth the Social Security Administration SSA for your work, time and income. So you must file the return within three years, three months and 15 days after the tax year for which you earned the income for which you want the credit. That's generally like a statute of limitations. So you want to make sure that you file the tax return. So to be in compliance with the law number one and then you want to make sure that if you have to pay the Social Security that at least you're getting the benefit of it calculated into the benefit program. So that means if you didn't file a return reporting your 2019 self-employment income, you'd have until April 15, 2023 to correct it. However, this grace period doesn't exempt you from any penalties and back taxes you may owe due to filing late. When you don't have to pay Social Security taxes, you don't owe Social Security taxes on the portion of your wages that exceed a certain earnings threshold. The wage index for 2022 is $147,000 up from $142,800 in 2021 and you don't owe Social Security taxes on the portion of your earnings that exceed that amount. So we talked about that threshold before. Once you clear that threshold, even if you earn more money, you're not paying more taxes. And part of that is because when you think about the benefit calculation, you're not getting any added benefit for income that's passed that threshold. So let's say your annual earnings were $148,000. The percentage of taxes you owe would be applied up to the first $147,000 but not the $1,000 above that. This annual cap on Social Security taxes also applies to employees who work for someone else. Qualifying for Social Security benefits. Anyone born in 1929 or later needs 40 Social Security work credits, the equivalent of 10 years of work to qualify for Social Security benefits. So we got basically the 10 years. So you want to think of that minimum requirement if you're not hitting that threshold. You earn one credit for every quarter that you earn at least $1,510 in 2022, which was $1,470 in 2021. So you can then go back and see, try to calculate if you're hitting at least the minimum credits there and take into consideration time value of money to see what that minimum threshold is in prior years. The number changes annually. Even if your business isn't particularly successful or you only work part-time or occasionally, it's not difficult to earn the Social Security credits you need. Even if your earnings fall below this threshold or your business has a loss, there are some alternative ways to earn Social Security credits. These optional methods may increase the amount of self-employment tax you owe, but they'll help you get the work credits you need. So if you're close to that threshold, you're coming up on Social Security retirement age and you're not qualifying for the minimum to get some benefit, then maybe that would be a time to focus more on it. Your eventual benefit payments do take your earnings into account. If you never earned much money from a lifetime of self-employment, don't count on getting a large Social Security check-in retirement. If you started claiming benefits this year, for example, and your average monthly earnings worked out to just $800, your monthly Social Security retirement benefit would be $720, assuming you're at full retirement age. That's not much. But if you managed to get by on an average of $800 a month during your working years, you could probably work with a monthly benefit payment of $720 in retirement. Specific categories of earnings don't count towards Social Security for most people, such as stock dividends, loan interest, and real estate income. So other kinds of income aren't usually going to be subject to Social Security. They're going to be self-employment income or income from active works, such as W-2 income. This means you don't pay Social Security taxes on this income and it also isn't used to calculate your future benefits. The exception is if your business operates in one of these areas that don't count. Self-employed stockbrokers, for example, do count stock dividends towards their Social Security earnings because that's like their full business. It's not a passive income for them. Do I pay Social Security if I am self-employed? Yes, you pay Social Security if you are self-employed. Those new to working for themselves need to know that your employer paid half of your Social Security contributions and you paid the other half now that you are self-employed. You are also your employer and now you are responsible for making the entire Social Security contribution amount yourself. Can you check on your Social Security? You can check your Social Security contributions and award status by logging into the Social Security website and creating a quote, my Social Security account or end quote account. So you can check that out on their website. When are you eligible for Social Security benefits? You are eligible for benefits at age 62. However, you will be collecting a reduced amount. Those who wait until age 67, if they were born after 1960, will collect a full amount. Those who wait until age 70 will see a significantly increased benefit amount. The bottom line, Social Security isn't much different whether you're self-employed or work for someone else. Self-employed individuals earn Social Security work credit the same way employees do and qualify for benefits based on their work credits and earnings. Although some of the planning that might be involved might be a little bit more complex for self-employed. Business tax deductions create the biggest difference. If you work for someone else, you pay Social Security taxes on all of your earnings up to the $147,000 cap in 2022. But if you work for yourself, deductions you claim on Schedule C can make your taxable income substantially lower that can decrease your Social Security taxes in the present and potentially lower your Social Security benefits later. Now also again, remember about the spouse that is involved as well. So we might talk about the relationship between spouses and the effect on Social Security if you have two married individuals in some way connected to a business for example. But we'll talk more about that later possibly.