Incorporating to save on payroll taxes? Understand the trade-offs!

Disclosure: This is not tax filing advice or legal entity advice. If you need legal or tax advice, please consult with the appropriate professionals.

One popular and widely used strategy to help business owners save on payroll taxes (FICA) is to incorporate their business (or LLC) and elect the S corporation tax treatment with the IRS.

Corporations are required to pay out what is termed (but seemingly difficult to quantify) a "reasonable compensation."

The base salary income is what FICA taxes are paid on. As those of us who are self-employed, that means paying both the employee and employer portions of FICA. The employee pays 6.2% and the employer pays 6.2% for a total of 12.4% up to the Social Security Wage Base. For 2025 that amount is $176,100.

"FICA also includes the Medicare tax of 2.9% (1.45% from employee + employer), with an additional 0.9% surtax on earned income above $200,000 for individuals or $250,000 for married couples, which is paid by the employee only."

Saving payroll taxes is good, right?

When your focus is profitability and immediate cash flow, absolutely it is.

The Social Security Tradeoff

Social Security only counts your eligible wages and income for your earnings record to determine your future retirement benefit calculations. That is limited to the amount you pay along the way subject to FICA contribution taxes.

While it is not recommended to plan on being reliant only on Social Security in retirement, if one does not save additional funds or have other investments to supplement in retirement... you won't have the retirement you desire.

Real estate is one such business with many tax advantages. There are times when I meet with someone who consistently reported low earned income — often due to relying on rental income, distributions, or aggressive tax strategies — and now receives only a few hundred dollars in monthly Social Security benefits. Why? Because their wage bases where they paid social security was very low.

This puts more pressure on your other retirement savings to outperform what you could have had with Social Security.

Crunching the Numbers

What does the math look like?

Let's assume you are self-employed and you chose to pay taxes on $70,000 of your income and just receive a $100,000 capital distribution (which is not subject to payroll taxes).

We'll just look at the Social Security part of the wage base, not the part including Medicare.

$100,000 x 12.4% = $12,400.

Assuming this was a level amount over 20 years, that would be a total of $248,000 of payroll taxes (not indexed for inflation).

If that money was invested at a conservative 6% rate over a 20 year period, it would grow to $456,141.

Compared to what? Is "investing" in Social Security better than doing something else?

Social Security actually has a benefit projection calculator!

https://www.ssa.gov/benefits/retirement/planner/AnypiaApplet.html

If you want to play with it, one important factor to keep in mind is that Social Security will average out your top 35 years of earnings and apply an inflation factor to it.

For my example, I put in $200,000 per year (more than the current FICA wage base) and put it in for 35 years.

Then I put in my birthdate and age 70 to claim maximum benefits.

My maximum benefit was estimated at $4,916 at 70 years old in today's dollars.

For future "inflated" dollars:

Of course, this is based on the benefits and the Social Security program as it is now.

Let's look at the other end of the spectrum. What happens if someone consistently earns at or above the wage base for 35 years and delays benefits until age 70?

Let’s compare this to our earlier payroll tax savings example. While it’s not a perfect apples-to-apples comparison, it helps illustrate the potential long-term value of contributing to Social Security.

It's an additional inflated value of $6,214 per month or $74,568 per year.

Paid in $248,000 (in my earlier example) to guarantee an additional $74,568 per year?

Let me put it this way: In just over 3 years, you got your money back and it's a guaranteed payment for the rest of your life.

Saving money on payroll taxes only makes sense to do if you will contribute far more than the payroll taxes in other retirement programs.

High-Impact Retirement Alternatives

A Solo 401(k) is one possibility. You can contribute up to $23,000 as an employee AND up to 25% of your net self-employment income as an employer. The total combined limit is up to $69,000 if you're under age 50 and up to $76,500 if you're 50+ with catch-up contributions. This can work for you and your spouse.

Cash Balance or 412e3 Pension plans are another possibility and work especially well when you have employees. These plans allow for allocation formulas that often favor owners and key employees, meaning a larger share of the contributions can go to the business owner. Contributions can exceed $100,000 - $300,000+/year! The older you are, the more you can contribute!

The Bottom Line

Work with a qualified CPA or retirement plan consultant who can model both the short-term tax savings and long-term retirement outcomes, so you can make the most informed decision possible.