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How to Reduce Social Security and Medicare Taxes

Audio version available here (1 min. 55 sec.)


Part of nearly all Americans’ tax obligations are FICA taxes, which include Social Security and Medicare fees. Any W-2 employee automatically has FICA taxes withheld from their paychecks, while independent contractors need to assess and pay FICA taxes on their own. But what about business owners?


FICA taxes are calculated as 12.4% of your income for Social Security while Medicare is 2.9%. W-2 employees only have to pay half, which is automatically withheld from their paychecks, and their employer covers the other half. For those who are self-employed, the entire combined 15.3% of FICA taxes must be paid on your own. This can be especially burdensome if you’ve hit the income ceiling for Social Security ($168,600), saddling you with a $20,906 tax balance to pay.


Unlike Social Security, Medicare has no tax ceiling. This means that the 2.9% tax will be assessed on any amount of income you make. Additionally, once you hit a certain threshold, there is an extra 0.9% Medicare tax imposed on the extra income. So, what is the solution to reducing these taxes when your business is profitable?


Most commonly, business owners will turn their business (such as a sole proprietorship or partnership) into an S corporation. Why? S corporations are pass-through entities, meaning that “taxable income passed through to an S corporation shareholder and cash distributions paid to a shareholder are not subject to federal employment taxes”. This allows you, as a shareholder employee, to be paid a more modest salary that doesn’t hit the income ceiling for Social Security or trigger the extra Medicare tax. Other cash distributions passed through the S corporation will not be subject to FICA taxes.


The catch here is that you will need to pay yourself a reasonable compensation to avoid IRS scrutiny. If the IRS suspects you of purposely paying yourself a minimal wage to evade FICA taxes, then you risk triggering an audit and potential back taxes and penalties.

The key is determining a reasonable compensation. You can do this with the help of our tax professionals at XQ CPA. Reach out to us for a tax consultation. Prefer to do it yourself? Read XQ CPA’s tax planning book How to Grow Your Wealth Through Tax Planning for a step-by-step guide.


Phone: 832-295-3353


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Want to pay less taxes? Read XQ CPA's official tax planning guidebook! How to Grow Your Wealth Through Tax Planning.

close up of 1040 and W-4 tax forms under pile of $1 bills

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