Social Security and Self-Employment

The fastest growing segment of business startups is composed of businesses run by seniors (called seniorpreneurs). The U.S. Small Business Administration reported that 15% of workers expect to start their own businesses when they retire and many seniors already own businesses.

How does self-employment impact the receipt and taxation of Social Security benefits? The following information is based on 2014 cost-of-living changes.

Limits on earnings
Your age when you start to collect Social Security benefits impacts whether those benefits are reduced.

  • If you are at least age 62 but not age 66: You lose $1 of benefits for each $2 of earnings over a set limit (the 2014 limit is $15,480). "Earnings" includes taxable compensation from a job and net earnings from self-employment.
  • If you are age 66 or older: You can earn any amount without a loss in Social Security benefits. For months prior to the 66th birthday in the year of this birthday, benefits will be reduced by $1 for each $3 over $3,450 per month in 2014.

There is a special rule for the first year of retirement for those under age 66. There will be no benefit reduction for any month in which 2014 earnings do not exceed $1,290 (1/12 of $14,480) (the "first year rule"). For example, if you are age 64 and earn $50,000 from January to August 2014 but then move to part-time work and begin collecting Social Security benefits, you could earn $1,000 a month in September through December without any loss of benefits collected in those months. However, if you are self-employed, the number of hours worked determines whether you're retired and allowed to use this favorable rule for the first year in which you collect benefits while under age 66. In general, if you work more than 45 hours a month in self-employment, you are not retired; if you work less than 15 hours a month, you are retired. If you work between 15 and 45 hours a month, you are not considered to be retired if the work requires a lot of skill or you are managing a sizable business.

Impact on future benefits
You can start collecting Social Security at age 66 and continue to earn any amount of income without a loss in benefits. The earnings count toward future benefits. In other words, you get credit for the earnings, which can increase future benefits. The process is automatic, based on withholdings from wages or payments of self-employment tax reported to the Social Security Administration.

If you delay collecting retirement benefits, the monthly amount you ultimately get will be larger. More specifically, benefits are increased by 8% per year (2/3 of 1% per month) for every year you delay collecting benefits. For example, if you postpone collecting benefits until age 68, your benefits are increased by 16% (8% times 2 years). However, once you reach age 70, no more credit for working can be accrued.

Taxation of Social Security benefits
For federal income tax purposes, benefit payments may be counted differently. If you have little or no other income, they are tax free. If you have other sources of income, including business profits, they may be counted toward your gross income at the rate of 50% or 85%. The includible portion depends on your other income, including tax-exempt interest. Details about the taxation of Social Security benefits can be found in IRS Publication 915.

State income taxes. Most states do not tax Social Security benefits. However, states that base their income taxes on federal taxable income effectively tax benefits to the same extent that they are taxed for federal tax purposes. Find the tax treatment of Social Security benefits in your state from the Tax Foundation.

Other points
Regardless of your age or whether you're collecting benefits, you continue to pay Social Security tax on your earnings. For self-employed individuals, this is figured on Schedule SE of Form 1040. One-half of the Social Security tax, along with one-half of the Medicare tax, paid by self-employed individuals is deducted as an adjustment to gross income.

You can go on Medicare for health coverage starting at age 65. Your work status and the Social Security age threshold have no impact on Medicare eligibility.

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