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What is it?
Reducing or eliminating compensation in excess of the
maximum earnings base is a strategy that may help you minimize Social Security
payroll taxes or self-employment taxes. You can reduce or eliminate
compensation you receive in two ways: (1) by working less or not at all once
you have reached the maximum earnings limit in any one year, or once you have
earned the maximum you can in each of the 35 highest earnings years used to
calculate your Social Security retirement benefit, or (2) by converting your
compensation to a nontaxable form.
Who can use this strategy?
You probably don’t work just to earn a future Social
Security benefit. You work because you have to, because you like to, or because
you’re not yet ready to retire. However, some workers (i.e., business owners)
have more flexibility than others in determining how much they earn or how
they’re compensated for working.
Anyone whose annual earnings have equaled or exceeded
the maximum earnings base in at least 35 years of employment
Your Social Security retirement benefit is based on your
average indexed monthly earnings (AIME). Your AIME is calculated by averaging your 35 highest years of indexed and
nonindexed earnings and applying a benefit formula to that average. If, in each
of those 35 years, you earned an amount equal to the maximum earnings base for
that year, you will receive the maximum Social Security retirement benefit when
you become entitled. If you continue to work once you have 35 years of maximum
earnings recorded on your Social Security record, you won’t receive any
additional retirement benefit, and the payroll taxes you pay will, in effect,
be wasted. The maximum earnings base changes from year to year; in 2026,
it’s $184,500.
Anyone who expects to have earnings in excess of the
maximum earnings base during any one year
If your annual earnings exceed the maximum earnings base
during any one year, you won’t pay FICA taxes on those excess earnings, but
you’ll pay Medicare taxes on those earnings. When you reduce or eliminate the
compensation you receive over the maximum earnings base, you’ll save payroll
taxes on the excess amount. If you’re an employee, you will save 1.45 percent
of that amount; if you’re self-employed, you’ll save 2.9 percent of that
amount.
How does it work?
You estimate your lifetime or annual earnings
To estimate your lifetime earnings, you can go to the Social Security Administration’s website (ssa.gov) and sign up for a
my
Social Security account so that you can view your Social
Security Statement.
This statement includes a detailed record of your lifetime earnings. To estimate your current annual earnings, use your paycheck stubs or, if you’re
self-employed, your self-employment earnings estimate.
Determine how much you might save in payroll or
self-employment tax if you reduce or eliminate compensation
Determining how much you should save will depend on
whether you’re the employer or the employee and how much your excess earnings
are.
As a self-employed person, Cornelia earned $11,600 in
excess of the maximum earnings base for that year. If she reduced her
compensation to the maximum earnings base for that year, she would save $336.40
(2.9 percent of $11,600) in Social Security taxes.
Decide whether you can stop working or try to convert
compensation to a nontaxable form
Once you determine how much in self-employment taxes or
payroll taxes you can save, decide how you want to reduce or eliminate your
compensation in excess of the maximum base amount. You might choose to stop
working if, for example, you’re already past minimum retirement age (currently
62).
You might choose to convert compensation to a nontaxable
form if you own a business or are employed by a business. Nontaxable forms of
compensation (for Social Security purposes) include some fringe benefits and
investment income.
Strengths
Can save payroll taxes that otherwise would have been
wasted
The strategy is particularly effective if used by a
business owner who can receive nontaxable benefits in lieu of salary. Or by a
person who works after retirement and already receives a benefit close to the
maximum due to the impact of excess earnings on a retirement benefit.
Tradeoffs
Your tax savings might be minimal if you use this
strategy to reduce your payroll taxes in only one tax year
Note that in the example above, Cornelia only saved
$336.40 by reducing her income by $11,600. If she had been an employee instead
of being self-employed, she would have saved only half that amount. However, if
she received nontaxable compensation or limited her earnings in several years,
she might save enough to make using this strategy worthwhile.