Income Types Not Subject To Social Security Tax: Are You Building A Tax Efficient Passive Income Portfolio?


The government gonna knock you out!

For 2017, so far we’ve got:

* A 0.5% increase in borrowing costs for mortgages, student loans, and consumer loans

* A Federal Reserve that plans to keep on hiking the Fed Funds rate

* Rising rents for renters who voted for more wasteful government spending through higher property taxes

* Rising property taxes for homeowners who don’t have tenants to pay the cost

* A 25% increase in oil prices as OPEC cuts production

* A likely 5% increase in income taxes for individuals/married couples making more than $112,500/$225,000 AGI a year

Why stop there? Let’s tax more people to help pay for our underfunded Social Security system!

The maximum amount of earnings subject to the 6.2% Social Security payroll tax will climb a record 7.3% in 2017 to $127,200 from $118,500 in 2016. In other words, those lucky enough to have jobs and earn $127,200 or more will have to pay $539.40 more a year in Social Security taxes ($127,200 – $118,500 = $8,700 X 6.2% = $539.40). Thus, the total annual Social Security tax bill for a $127,200 or greater income earner increases from $7,347.00 in 2016 ($118,500 X 6.2%) to $7,886.4 in 2017 ($127,200 X 6.2%).

But of course, you can’t forget about Medicare, which is 1.45% of all income earned. And Medicare doesn’t have an income cap! So the reality is that a $127,200 laborer will have to pay $7,886.40 in Social Security tax plus $1,844.40 in Medicare tax for a total of $9,730.80 in 2017.

If you are “unlucky” enough to be your own boss, you’ve got to pay the 6.2% Social Security tax + 1.45% Medicare tax times two (employer plus employee)! In other words, a self-employed individual making $127,200 will now have to pay $1,078.80 more in Social Security tax for 2017. The total annual Social Security + Medicare tax bill for a $127,200 self-employed income earner is now a whopping $19,461.6! And the great irony is, good luck trying to collect unemployment benefits if your business goes bust.

2017 FICA Payroll Tax Rates (Social Security + Medicare)

Out of the estimated 173 million workers who will pay Social Security taxes in 2017, about 12 million (7%) will be paying more. But as I’ve shown you before, anybody who makes between $100,000 – $200,000 and lives in a large city is considered middle class. Therefore, we can conclude the middle class is getting punched in the face even harder.

Don’t forget, there’s also the 0.9% Additional Medicare Tax on employees that went into effect in 2013. If you make more than the below thresholds, you’ve got to pony up 2.35% in Medicare taxes (1.45% standard + 0.9% additional). The semi good news is if you’re self-employed, the employer Medicare rate stops at 1.45% and is exempt from the additional 0.9% even if you make more than these thresholds. The bad news is these income amounts aren’t being adjusted for inflation, so more and more people are getting subject to the additional 0.9% every year.

  • $250,000 for married taxpayers who file jointly.
  • $125,000 for married taxpayers who file separately.
  • $200,000 for single and all other taxpayers.

The Positives Of Higher Payroll Taxes

It’s important to always look at the bright side of higher Social Security and Medicare taxes.

1) The more taxes we pay in, the higher the chance we’ll actually receive the full amount of Social Security and Medicare promised to us. Hopefully most of us have already completely written off any sort of Social Security benefits by the time we reach our 60s and 70s. It’s always good to have low expectations of government promises.

2) We insure that more working people pitch in to pay for our great country. It’s very hard to avoid payroll taxes. Yes, if you do the math, 173 million workers who will pay payroll taxes equals only 54% of the estimated 319 million people in the United States. But 54% of the nation paying taxes is better than a sharp stick in the eye! The other 46% of the population are too young, too sick, too poor, too unwilling, or too old.

3) The government controls more people by making them afraid of becoming free thinkers who are independently wealthy. Why do you think the first thing Chairman Mao and Fidel Castro did when they got into power was confiscate land from the wealthy and send them to farm? Having to pay 7.65% in payroll taxes as a laborer is already painful. To pay 15.3% in payroll taxes as an entrepreneur is oppressive. The less people realize the massive upside of being an entrepreneur, the less people will threaten government.

4) Higher taxes encourage people to make a whole lot more than $127,200 to get a “bargain” on every incremental dollar earned. For example, if the Trump tax cut on the top 1% goes through, then the fake news blogger who makes $827,200 a year will not only get to avoid paying 12.4% in Social Security tax on $700,000 of his income ($827,200 – $127,200), he’ll also get to pay 6.4% less in federal income taxes (39.6% down to 33%) on ~$400,000+ of his income ($827,200 – $415,000)! He’ll work hard to pump out more fake news to manipulate the masses.

Ways To Counteract Higher Payroll Taxes

If you’re stuck in the rat race, there’s really no way around paying Social Security and Medicare taxes. If you’re earning close to the maximum income of $127,200 subjected to Social Security taxes, it’s not like you’re going to tell your boss to give you a pay cut. Instead, you’re going to continue kissing butt in hopes of getting that amazing 3% pay raise next year just so you can afford to pay for the tax hike!

If you’re self-employed, you’ve got more flexibility. You could choose to pay yourself a lower wage and give yourself more in distributions, which aren’t subject to payroll taxes. For example, let’s say you brought home $200,000 in operating profits (revenue – gross profits and operating expenses) before taxes. You could theoretically pay yourself $30,000 in wages and give yourself a $170,000 distribution so you’re only paying $4,590 in Social Security and Medicare taxes ($30,000 X 15.3%) versus taking home $200,000 in wages and $0 in distributions and having to pay $15,772.80 SS ($127,200 X 12.4%) + $5,800 Medicare ($200,000 X 2.9%) = $21,572.80. That’s a huge $16,982.80 in tax savings!

If the $200,000 entrepreneur was a W2 employee instead of being self-employed, his/her tax bill would be $7,886.4 SS ($127,200 X 6.2%) + $2,900 Medicare ($200,000 X 1.45%)  = $10,786.4. So it’s hard to call $16,982.80 a complete “savings.” The risk of paying only 15% of your operating profits as a salary is that you might get audited. How much an entrepreneur with an S-Corp can pay himself in income and distributions is a gray area. I’ve argued for a ratio of no greater than 50/50.

Finally, the absolute best way to counteract ever-rising payroll taxes is to simply earn income that is NOT subject to payroll taxes! What types of income are not subject to payroll taxes? Here’s a list.

Investment Income Not Subject To Payroll Taxes

* Dividend income

* Bond income

* Rental income

* Venture debt income

* Private equity income

* Real estate crowdsourcing income

* P2P income

* CD interest income

* Capital gains

* Student income, ministerial income, exempt wage income

Below is a look at my passive income streams to give me an idea of how much of that income is payroll tax free income.

Financial Samurai Passive Income Not Subject To Payroll Taxes

What’s also good about investment income is that you may get some tax breaks on income and capital gains. The tax rate on long-term (more than one year) gains is 15%, except for high-income taxpayers ($400,000 for singles, $450,000 for married couples) who must pay 20%. High-rate taxpayers will typically pay the healthcare surtax as well, for an all-in rate of 23.8%.

Qualified dividends have a tax rate of 15%. Meanwhile, there are no federal taxes due on income produced by municipal bonds. For those who invest in their own state’s municipal bonds, there isn’t state income tax due either.

I’ve always known the government would continue to raise payroll taxes forever. Inflation is running at ~2%, but here the government is raising the payroll tax income limit by 7.3% for 2017. Yes, they kept the payroll tax income limit flat from 2015 to 2016, but a 7.3% increase over two years is still much higher than 2% inflation per year.

Knowing the government will never efficiently manage other people’s money, I started building a passive income portfolio in 2000 so I could have more of my money back. As soon as you can make enough passive income to cover all your living expenses, you are not only free to do whatever you want, you’re also free of the 7.65% payroll tax for employees and 15.3% payroll tax for the self-employed!

Wealth Is More Important Than Income

Because the government is always going after income, wealth is much more important for financial freedom. For example, you could be worth $10,000,000 and not have to pay payroll taxes or income taxes since you can live off your investments. You could also partake in subsidized healthcare under the Affordable Care Act. Further, your kids could get 100% of their college tuition paid for by universities given they determine grants by income and not by wealth.

The more you work, the more you have to pay in taxes. Instead, work smarter by focusing on building more investment income or equity in a business, especially if corporate taxes are going to drop to 15%. You can build wealth up to $5.49M as an individual or $11.98m as a married couple before the estate tax kicks in.

From now on, really think about how all your income sources are taxed. Do you really want to work all day for the privilege of paying federal income tax, state income tax, city income tax, social security tax, medicare tax, and so forth? Just like inflation, tax increases will never end.

Readers, are you excited to pay more FICA taxes for 2017? Why don’t more people focus on building income that is not subject to ever rising payroll taxes? What are some of the steps you are taking to reduce your tax liability? Have you decided to apply for a government job yet to take advantage of rising taxes?