Laurence Kotlikoff is a professor of economics at Boston University who has been answering questions and writing columns about Social Security each week for the past two years on PBS NEWSHOUR’s website. OpenRetirement has asked Professor Kotlikoff to post a Q&A each day from those columns. He has also developed software, called Maximize My Social Security, to help retirees secure the highest lifetime Social Security benefits. You can find the software here: www.maximizemysocialsecurity.com
Question: Both my wife and I work for our own business. I am seven years older than she is. We want to maximize Social Security benefits by setting a large salary, but at the same time, we want to set an optimal salary for each where we don’t overpay payroll taxes — taking into consideration that we can get distributions as well. How do we figure each one’s salary?
Answer: If you worked for more than one business, you and your employer (which would be yourself in the case one business is your own) could be forced to overpay Social Security payroll taxes insofar as you get a refund of employee FICA (Federal Insurance Contribution Act) taxes once you exceed the taxable ceiling, which this year is $113,700. But you don’t get a refund of employer FICA taxes. If you just work for one employer, that employer will stop sending in both portions of the tax as soon as you reach the $113,700 threshold.
But if you earned, say, $100,000 from three employers, each of your three employers would end up paying half of the 12.4 percent Social Security tax — in other words, 6.2 percent on $100,000. You’d get credited on your federal income tax for paying the 6.2 percent in Social Security employee tax on your earnings in excess of $113,700 (i.e., on $300,000 minus $113,700), but your three employers wouldn’t get credit for their having to pay 6.2 percent on the excess.
This is the only way I can think of that one can, technically speaking, overpay payroll taxes. Yes, in my example, the three employers are collectively overpaying, but their overpayment would be coming out of your hide insofar as workers’ net earnings reflect what employers have to pay on their behalf.
Now back to your situation, Bernie. I guess your question comes down to deciding whether to pay yourself or your wife the income from your business. This decision can, indeed, affect your benefits since Social Security calculates one’s basic benefit amount (the Primary Insurance Amount or PIA) from the average of one’s highest 35 years of covered earnings, with covered earnings prior to age 60 adjusted for economy-wide real wage growth.
So if you pay, say, all or most of this year’s earnings to your wife and she’s had a relatively low earnings history, her earnings this year could prove to be one of her 35 highest earnings years, and, therefore, raise her average monthly earnings (called her Average Indexed Monthly Earnings or AIME) and her PIA. On the other hand, if you paid yourself all the earnings, it might raise your average and your PIA. Use an Internet Social Security calculator to help you figure this out.
But, and this is a big but, the IRS expects you to allocate your earnings based on your actual respective economic contributions. Transactions that are made simply to lower your taxes are, as I understand it, strictly illegal. So I would be very careful about doing anything in this realm that could run you afoul of the IRS.
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