How to Reduce FICA Tax Through Benefits and Business Strategies

FICA taxes, which fund Social Security and Medicare, are automatically deducted from employee paychecks and can be a significant expense for both workers and employers. While these contributions support essential programs, there are legal ways to minimize the amount owed.

By strategically using benefits and business structuring methods, individuals and businesses can reduce their FICA tax liability.

Wage Base Limit Considerations

The amount of wages subject to Social Security tax is capped each year by the wage base limit, which is adjusted annually for inflation. In 2024, this limit is $168,600, meaning earnings above this threshold are not subject to the 6.2% Social Security tax. However, the Medicare portion of FICA has no cap, and an additional 0.9% Medicare surtax applies to wages exceeding $200,000 for single filers and $250,000 for married couples filing jointly.

For employees earning near the wage base limit, timing bonuses or other compensation strategically can help manage FICA tax liability. If a year-end bonus pushes total earnings above the limit, only the portion below the cap is subject to Social Security tax. Employers can also defer taxable wages into future years to reduce FICA exposure in a given tax period.

Business owners who pay themselves a salary should consider the wage base limit when determining reasonable compensation. Paying a salary above the cap results in additional Medicare tax obligations but no further Social Security tax. This can be a factor when deciding how to allocate income between salary and other forms of compensation, such as dividends for S corporation owners, which are not subject to FICA taxes.

Employee Benefit Arrangements

Employers can offer benefits that reduce taxable wages, lowering FICA tax liability for both the company and its workers. These benefits must comply with IRS regulations to qualify for tax-exempt treatment.

Health Savings Accounts

A Health Savings Account (HSA) allows employees with a high-deductible health plan (HDHP) to set aside pre-tax money for medical expenses. Contributions made through payroll deductions reduce taxable wages, lowering income and FICA taxes. In 2024, the IRS contribution limits for HSAs are $4,150 for individuals and $8,300 for families, with an additional $1,000 catch-up contribution for those aged 55 and older.

For example, an employee earning $60,000 who contributes $3,000 to an HSA reduces their taxable income to $57,000. This lowers their Social Security tax by $186 (6.2% of $3,000) and Medicare tax by $43.50 (1.45% of $3,000), saving a total of $229.50 in FICA taxes. Employers also save $229.50 per employee contributing $3,000 by avoiding their share of FICA taxes on the contributed amount.

To qualify, the HSA must be paired with an HDHP meeting IRS minimum deductible requirements ($1,600 for individuals and $3,200 for families in 2024). Funds can be used tax-free for qualified medical expenses, and unused balances roll over indefinitely.

Flexible Spending Accounts

A Flexible Spending Account (FSA) allows employees to set aside pre-tax dollars for medical expenses, reducing taxable wages and lowering FICA tax liability. Unlike HSAs, FSAs do not require a high-deductible health plan, making them accessible to more employees. The IRS limit for FSA contributions in 2024 is $3,200 per employee.

For instance, an employee earning $50,000 who contributes the full $3,200 to an FSA reduces their taxable income to $46,800. This results in a Social Security tax savings of $198.40 (6.2% of $3,200) and a Medicare tax savings of $46.40 (1.45% of $3,200), totaling $244.80 in FICA tax savings. Employers also save $244.80 per participating employee by not paying their share of FICA taxes on the contributed amount.

One limitation of FSAs is the “use-it-or-lose-it” rule, which generally requires funds to be spent within the plan year, though some employers offer a grace period of up to 2.5 months or allow a carryover of up to $640 in 2024. Employees should estimate their medical expenses carefully to maximize savings without forfeiting unused funds.

Dependent Care Benefits

Employers can offer Dependent Care Assistance Programs (DCAPs) that allow employees to pay for childcare or dependent care expenses using pre-tax dollars. The IRS permits up to $5,000 in tax-free dependent care benefits per household ($2,500 for married individuals filing separately).

For an employee earning $70,000 who contributes the full $5,000 to a DCAP, taxable wages are reduced to $65,000. This results in a Social Security tax savings of $310 (6.2% of $5,000) and a Medicare tax savings of $72.50 (1.45% of $5,000), totaling $382.50 in FICA tax savings. Employers also save $382.50 per participating employee by avoiding their share of FICA taxes on the contributed amount.

To qualify, expenses must be for dependents under age 13 or disabled dependents who require supervision. Eligible expenses include daycare, preschool, summer camps, and in-home care providers. Employees should ensure they do not exceed the $5,000 limit, as any amount above this threshold is treated as taxable income.

Adjusting Business Structure If Self-Employed

Self-employed individuals must pay the full 15.3% self-employment tax, which consists of 12.4% for Social Security (on earnings up to $168,600 in 2024) and 2.9% for Medicare. This makes entity selection an important consideration for tax efficiency.

Operating as a sole proprietor or a single-member LLC means all net earnings are subject to self-employment tax. Transitioning to an S corporation can provide tax savings by allowing the owner to split income between salary and distributions. The IRS requires S corporation owners to pay themselves a “reasonable salary,” which is subject to payroll taxes. However, any remaining profits can be distributed as dividends, which are not subject to self-employment tax.

For example, if an S corporation owner earns $120,000 in total profits and pays themselves a $70,000 salary, only that $70,000 is subject to Social Security and Medicare taxes. The remaining $50,000 is classified as a distribution, avoiding the 15.3% self-employment tax. This results in a tax savings of $7,650 ($50,000 × 15.3%) compared to a sole proprietor who would owe self-employment tax on the full $120,000. However, the IRS scrutinizes unreasonably low salaries to prevent abuse, so compensation should align with industry standards.

Limited partnerships offer another option, as only the earnings allocated to general partners are subject to self-employment tax. Limited partners, who do not engage in daily operations, are not required to pay self-employment tax on their share of the profits.

Retirement Contributions

Contributions to certain retirement plans can lower taxable wages, decreasing the amount subject to Social Security and Medicare taxes.

For employees, participating in a 401(k) or a 403(b) plan allows for pre-tax contributions that reduce taxable income. In 2024, the IRS permits up to $23,000 in elective deferrals, with an additional $7,500 catch-up contribution for those aged 50 and older. While these contributions lower federal and state taxable income, they do not reduce FICA tax liability because traditional 401(k) deferrals remain subject to Social Security and Medicare taxes. However, employer contributions and profit-sharing contributions are not subject to FICA taxes.

For business owners, adopting a SEP IRA or a solo 401(k) can provide significant tax benefits. A SEP IRA allows contributions of up to 25% of compensation, with a maximum of $69,000 in 2024. These contributions are fully deductible and not subject to payroll taxes.

Non-Taxable Reimbursements

Reimbursing employees for business-related expenses can reduce taxable wages, lowering FICA tax liability for both employers and workers. When structured correctly under an accountable plan, reimbursements are not considered taxable income.

Accountable plans require that expenses have a business connection, be substantiated with receipts, and that any excess reimbursements be returned. Common reimbursable expenses include travel costs, mileage, professional development fees, and home office expenses. Employers should ensure their reimbursement policies comply with IRS guidelines to avoid classification as taxable income.