The Best Way to Handle Higher Business Taxes
taxes on businesses will be increased, but this does not have to be a bad thing. With some careful planning, you can find the best salary for you as the business owner.
As a business owner or self-employed individual, you know that payroll and Social Security taxes can take a big chunk out of your earnings. But did you know that you may be paying double the taxes for the same Social Security benefits as those who work as employees? One way to minimize your taxes and maximize your retirement savings is to contribute to a small business retirement plan. By doing so, you can take advantage of tax breaks and save for your future at the same time.
I specialize in helping high-income business owners minimize their taxes while still accruing a meaningful Social Security benefit. I often get asked how they can do this, and the knee-jerk reaction might be to increase their salaries to the maximum for Social Security benefits and pay substantial income and payroll taxes. However, there are other options available that can help minimize taxes without sacrificing Social Security benefits. As a Los Angeles financial advisor, I work with clients from across the country, and the majority of my clients are subject to the high-income taxes of California. I can help them navigate the complex tax code and find strategies that will help minimize their tax liability.
Business Owners Get Double the Payroll Taxes
As a self-employed individual, you are required to pay both the employer and employee portions of the Social Security payroll tax. However, this is not an additional tax burden, as the total amount paid by self-employed individuals and employees is the same. For the 2022 tax year, the self-employment payroll tax is 15.3% on the first $147,000 of income. This includes 12.4% for Social Security and 2.9% for Medicare.
For those earning more than $147,000, there is some good news. The Social Security component goes away. You are left paying 2.9% to Medicare for a bit on your additional income. Eventually, a 3.9% Medicare Surtax kicks in on higher incomes. The Medicare surtax kicks in at $200,000 for single filers and $250,000 for those who are married and filing jointly.
Get the most out of your S-Corp with payroll tax savings!
As a business owner, you have the ability to limit how much of your income is subject to payroll taxes. As an employee-owner, you must pay yourself a reasonable salary, which is subject to payroll taxes. The remaining profits each year can be distributed without payroll taxes. However, it is important to consult with a tax professional and financial planner to determine what is a reasonable salary based on your income and job responsibilities.
If you want to minimize your payroll taxes, you can run your business on a very low salary. However, this will reduce your eventual Social Security benefits. If you're using the tax savings to add more to your retirement accounts, like a Solo 401(k) or Cash Balance Pension Plan, this shouldn't be a huge issue. However, if you're using the tax savings to spend, spend, spend, you likely won't be able to invest enough to maintain your standard of living in retirement.
Should You Increase Payroll to Increase Social Security Benefits?
There is no easy answer to how much of your income you should put through payroll to have the maximum retirement income. Social Security benefits will increase with more income put through payroll, but it is difficult to determine how much of a difference this will make. The conversation becomes more complicated if you have a spouse who also has a benefit or is self-employed. In these cases, it is important to speak with a financial advisor to get the best sense of how to maximize your retirement income.
I will say, in general, that if a married couple works together, it doesn't usually work in your favor to pay both spouses equally. For example, if your business has $500,000 of income, you wouldn't want each of you to take $250,000 of salary. This would mean more of your income would be hit by payroll taxes. Instead, a reasonable salary might be $100,000 for the business driver and, say, $30,000 for the second spouse who helps in a more administrative role. (Just giving an example here). The remaining $370,000 would be distributed as profits. I believe that this is not the best way to go about things because it creates an unnecessary burden on the business. It is better to have one spouse who is the primary breadwinner and one who brings in a secondary income. This way, the business can focus on its primary goal of making money and not on managing payroll taxes.
Higher Salaries Bring Higher Retirement Plan Contribution Limits
If you want to retire comfortably, it's important to take advantage of retirement plan contribution limits. For a Solo 401(k) in 2022, you can contribute $20,500 as an employee, and the employer (also you) can contribute up to 25% of your salary as a profit-sharing contribution. Business owners aged 50 or older can also make a $6,500 catch-up contribution as the employee resulting in a whopping total pre-tax contribution of $67,500. You would need a salary of at least $162,000 to make the maximum allowable Solo 401(k) contribution in 2022. By contributing the maximum amount to your retirement plan, you can ensure a comfortable retirement.
If you're looking to save on taxes, a Cash Balance Pension Plan could be a great option – especially for high-income earners. I recently worked with a husband-and-wife business owner team who were able to contribute more than $700,000 between their 401(k) and Cash Balance Pension Plan. By doing some tax planning and raising their salaries to allow for maximum contributions to retirement accounts, we were able to reduce their federal and California income taxes significantly. Remember, you only have to pay the total 15.3% payroll tax on the first $147,000 of salary. At higher income levels, you could be facing 37% federal and 13.3% state taxes.
As a business owner, it is important to keep in mind that tax planning is an essential part of running a successful operation. While it is crucial to focus on generating income, it is equally important to focus on minimizing taxes. By implementing proactive tax planning strategies throughout the year, business owners can save themselves a significant amount of money come tax season. So don't wait until the last minute to start thinking about taxes - start planning now to minimize your tax burden.
