How Avoiding FICA Taxes Can Actually Cost You | Nerd's Eye View by Michael Kitces
No one likes to pay any more in taxes than they have to; the less we’re taxed, the more we have money available for our own use, whether to consume or to save. Accordingly, it’s not surprising that there are many strategies available to try to (legally) reduce one’s tax burden.
However, in the case of FICA taxes, strategies that reduce earned income to avoid the tax also end out reducing the income used to calculate an individual’s Average Indexed Monthly Earnings, which in turn is used to determine future Social Security benefits. As a result, everything from S corporation dividend strategies to under-the-table cash payments that minimum payroll and/or self-employment taxes can also reduce that individual’s Social Security benefits as well!
In some cases, it turns out that the reduction in Social Security benefits is still worthwhile relative to the FICA taxes that can be saved. However, because of the so-called “bend points” used to calculate an individual’s Primary Insurance Amount under the Social Security rules, not all FICA tax avoidance strategies have the same consequences. For higher-income individuals, the foregone benefits can be minimal – or sometimes even zero – making the tax savings worthwhile, but for lower-lower individuals, the lost benefits can actually be quite high! In fact, those who don’t have enough years of income to qualify for Social Security benefits may evenwant to pay more in FICA taxes, to both increase their benefits and ensure that they can receivethose benefits at all!