Month: October 2026

Preface: “I pay my income tax and the government gives back what I got coming. Lord, but it ain’t much.” — Merle Haggard

Social Security – How Earned Income is Taxed to Fund Social Security

The following is the fifth in a series of blog posts on the subject of Social Security. The first four installments, which can be found here, here, here, and here:

• • • Reviewed the history of the Social Security program
    • Explained how to claim Social Security retirement benefits
    • Explained how to claim Social Security survivor and family member benefits
    • Explained how Social Security benefits are taxed

This fifth installment will discuss:

• • • How earned income is taxed to fund Social Security

Future posts in this series will address:

• • • Estimating Social Security’s returns on investment

The Bi-Weekly Bite

If you look closely at your bi-weekly paycheck, you will see a large hole. This hole is the gap between gross pay and net pay. The teeth marks reveal the identity of the biters. One of the largest is almost always “OASDI” a.k.a. Social Security. It is equal to 6.2% of your gross. Another hungry mouth is Medicare at 1.45%. Together, these make up the 7.65% employee half of FICA. If your gross was $10,000, you paid $765 in employee FICA.

As noted in a previous post in this series, FICA stands for Federal Insurance Contributions Act. It was introduced to fund the Old Age, Survivors, and Disability Insurance (OASDI) benefits established by the Social Security Act of 1935. At the time of its creation, FICA was set at 2%, but is now 15.3% of wages and self-employed income.

“No problem,” you might be thinking, “I’ll get some of it back as a refund when I file my taxes, right?” WRONG. FICA is non-refundable. Regular income tax in excess of your tax liability is an easy refund. But FICA and regular income tax are two parallel but separate tax systems  computed under different rules.

If you have no income tax liability for the year, you will be refunded whatever was withheld for regular income tax purposes, $235 in the above example. If you have some income tax liability but less than your withholding, you will be refunded the difference. But this does not apply to FICA withholding because FICA is used to fund Social Security benefits, not to offset income tax liability.

Furthermore, many types of payroll deduction such as pensions and health savings accounts will reduce your income that is subject to income tax. But nothing will reduce your income subject to FICA:

Notice that deductions for your pension and other benefits reduce your wages subject to income tax, but do not reduce your wages subject to FICA. FICA is computed as a percentage of your gross pay before other deductions.

How the Other Half Bites

But that is only half the damage done by FICA. In the above examples, your employer paid the full $10,000 of employee gross pay and is allowed to deduct it as a business expense. However, your employer also paid the employer half of FICA and it is allowed to deduct that as well. In other words, for every $10,000 you see in gross pay, your employer had to pay that plus another $765 that that you don’t even see.

So, for every $10,765 your employer pays to employ you, the government gets $1,530 in FICA while $9,235 is left over for you. Out of this you must then pay your regular income tax on a wage base considered to be $10,000.

“No problem,” you might be thinking, “The employer half of FICA is my boss’s problem, not mine.” But from your employer’s point of view, this is money paid to employ you. It is effectively part of your compensation package. In the end, it is that much less money that is left over that can be offered to you as take-home pay or benefits.

How FICA is Collected from the Self-Employed

If you are self-employed, you must pay both the employee and the employer halves of FICA in the form of self-employment tax. You do get to deduct the employer half from the amount of your income that is subject to regular income tax.

For the self-employed, if you have at least $400 in self-employed income, you must file an income tax return for the year even if you are not otherwise required to file. This is because you must pay the self-employment tax even if you have no ordinary tax liability.

This is similar to how FICA withholding for employees is not refundable even when they have no regular income tax liability. Employees do not even get the $400 safe harbor. Even if you only earned $1 at your job, 15.3¢ is getting collected in FICA. It respects neither the standard deduction, itemized deductions, student loan interest, child tax credit, or section 11 bankruptcy.

You may not think the term “self-employed” will ever apply to you. But if you receive any payment for work you did as a non-employee, you are subject to self-employment tax. This could be anything from babysitting or mowing lawns or selling popcorn at a sports event, to consulting fees or contract labor.

What Happens to FICA after It Is Collected?

“No problem,” you might be thinking, “I’ll get all that FICA back when I retire and collect my Social Security benefits.”

Well, maybe. But first, you have to live long enough to collect it. Not everybody does.

Second, even though Social Security is described as a trust fund held to pay out benefits, it is important to understand what this means and what it doesn’t mean. The U.S. Supreme Court has ruled in Flemming v. Nestor (1960) that paying into Social Security does not mean you have a legal claim to benefits. In other words, it is illegal for the government to use FICA money for any other purpose than to pay Social Security benefits. But there is no legal requirement that they pay the benefits. As far as who gets the benefits, it is first come first served. And there is no reason to assume there will be enough left for you when the time comes, even if you do live that long.

Third, and this will be the topic of a future post in this series, how much are those benefits worth compared to what you paid in over the course of your working life?

Monthly and Quarterly Payments and Filing Requirements

In addition to the financial toll it imposes, FICA also places reporting and remittance burdens on employers and the self-employed that raise the barriers to doing business and are likely a significant inhibitor to business formation in the United States. Businesses that do get off the ground must continually devote time, effort, and resources to monitoring their own compliance or paying third parties to assume these responsibilities for them.

Since employees have their share of FICA taken out of their wages by their employer in each pay cycle, they are not required to make any additional FICA-related payments or reports.

Employers are required to remit both their half and their employees’ half of FICA to the government on at least a monthly basis and to report the totals on Form 941 on a quarterly basis. Penalties for failing to make the required payments and filings are severe. This applies to all employers from the largest mega-corporation down to the smallest food truck.

The self-employed are required on a quarterly basis to pay estimates towards their expected annual amount of self-employment tax. You will incur penalties for not paying sufficient estimates in a timely manner even if you do not end up owing any income tax. Penalties on the self-employed will be waived if the annual shortfall is less than $1,000, or less than 10% of annual tax liability, or if the total of the year’s estimated payments would have covered the prior year liability.

The damage done by FICA to employers, employees, and to the self-employed is real and cuts deep: 15.3% of income wiped out before income tax or other deductions are even considered, let alone money left to pay for food, housing, clothing, or personal savings. FICA eats away your ability to generate capital, buy a home, start your own businesses, and leave something to your children. Unlike regular income tax, it cannot be refunded or abated or challenged by appeal or in tax court.

Preface: “Time is your friend, impulse is your enemy.” — John C. Bogle, founder of Vanguard

Make 2026 Count: Tax Planning for Your Traditional and Roth IRA Contributions

Saving for retirement is one of the better financial decisions you can make, but understanding the tax rules can sometimes feel like navigating a maze. Fortunately, 2026 brings increased contribution limits and new opportunities to strengthen your retirement savings. Whether you’re a business owner, employee, or approaching retirement, knowing how to use Traditional and Roth IRAs effectively can make a meaningful difference in your financial future.

For 2026, the IRS increased the annual IRA contribution limit to $7,500, up from $7,000 in 2025. Individuals age 50 and older can contribute an additional $1,100, bringing their maximum to $8,600. These limits apply to combined Traditional and Roth IRA contributions and cannot exceed eligible compensation. While the increased limits are welcome news, the real opportunity is choosing the right strategy for your circumstances.  

Traditional or Roth IRA: Which Is Better?

Traditional and Roth IRAs offer different tax advantages. A Traditional IRA may provide a deduction today, with deductible contributions and investment earnings generally taxed upon withdrawal. Roth IRA contributions are not deductible, but qualified withdrawals, including accumulated earnings, are tax-free.  

Consider Maria, age 45, who expects to be in a lower tax bracket during retirement. A deductible Traditional IRA may be attractive because she receives a tax benefit today. Her younger brother, Luis, age 30, expects his earnings to increase substantially. A Roth IRA may make more sense because he can pay taxes at today’s potentially lower rates and enjoy tax-free qualified withdrawals later.

The best retirement strategy isn’t necessarily the one that saves the most taxes today. It’s the one that creates the greatest long-term after-tax benefit.

Understanding the 2026 Income Limits

One of the most misunderstood IRA rules involves income limitations. Although taxpayers with eligible compensation can generally contribute to Traditional IRAs, the ability to deduct those contributions depends on income and participation in workplace retirement plans.

For 2026, the Traditional IRA deduction phases out for single taxpayers covered by workplace retirement plans between $81,000 and $91,000 of modified adjusted gross income (MAGI). For married couples filing jointly, when the contributing spouse participates in a workplace plan, the phaseout range is $129,000 to $149,000.

Roth IRAs have separate income restrictions, regardless of workplace retirement plan participation. For 2026, direct Roth contributions phase out between $153,000 and $168,000 for single taxpayers and between $242,000 and $252,000 for married couples filing jointly.  

These thresholds are important because exceeding them can reduce or eliminate valuable tax benefits. Taxpayers above the Roth income limits may wish to discuss alternative strategies, including Roth conversions, with their CPA.

Married Couples: Don’t Overlook the Spousal IRA

Here’s an opportunity many families miss. A spouse who earns little or no income may still qualify to contribute to an IRA when the couple files jointly and has sufficient combined eligible compensation.

For example, suppose Dana works full-time while her spouse, Sam, stays home raising their children. Even without a paycheck, Sam may contribute to an IRA based on Dana’s compensation. If both spouses are under age 50, the couple could potentially contribute $15,000 combined for 2026. If both are age 50 or older, that amount increases to $17,200.

For a spouse who is not covered by a workplace retirement plan but whose spouse is covered, the Traditional IRA deduction phases out between $242,000 and $252,000 of joint MAGI in 2026.

You Have Until April 2027 to Contribute

Unlike many year-end tax planning decisions, IRA contributions generally do not need to be completed by December 31. For most taxpayers, 2026 contributions can be made through April 15, 2027, the original federal income tax filing deadline, excluding extensions.

This flexibility allows you to review your annual income, evaluate tax brackets, and determine the most advantageous contribution before filing your return. Remember to designate the correct tax year when making contributions.

Nondeductible Contributions: Keep Accurate Records

If your income exceeds the Traditional IRA deduction limits, you may still qualify to make a nondeductible contribution. However, these contributions require careful reporting.

Nondeductible Traditional IRA contributions are generally reported on IRS Form 8606, which tracks contributions made with after-tax dollars. Proper reporting helps prevent those amounts from being taxed again when withdrawn. If your IRA contains both deductible and nondeductible funds, special allocation rules apply to distributions.

For higher-income taxpayers, nondeductible contributions followed by Roth conversions may provide additional planning opportunities. However, existing pretax IRA balances can create unexpected tax consequences under the IRA aggregation and pro-rata rules.

Avoid the Costly 6% Excess Contribution Penalty

Contributing too much to an IRA can create an expensive mistake. Excess contributions generally trigger a 6% annual excise tax for each year the excess remains uncorrected, subject to statutory limitations. For example, Miriam, age 40, contributes $9,000 for 2026 despite having a $7,500 limit. Her $1,500 excess could result in a $90 excise tax each year until corrected.

Fortunately, the IRS provides correction procedures, including timely withdrawal of excess contributions and associated earnings when required. Reviewing contributions before filing your return can help avoid unnecessary penalties.  

The Bottom Line: Make Every Retirement Dollar Count

The increased 2026 IRA limits offer valuable opportunities to build retirement wealth, but successful planning involves more than maximizing contributions. Choosing between Traditional and Roth accounts, understanding income limitations, coordinating spousal contributions, and maintaining accurate tax records can significantly improve long-term financial outcomes.

For business owners and higher-income individuals, IRA decisions should also be coordinated with workplace retirement plans, projected tax brackets, cash flow, and broader financial goals. Before making your 2026 contributions, consider reviewing your retirement strategy with your CPA or financial advisor. A little planning today can create meaningful financial benefits for years to come. The goal isn’t simply to save more for retirement. It’s to keep more of what you save and make every retirement dollar count.

Preface: “There is nothing quite so useless as doing with great efficiency something that should not be done at all.” — Peter F. Drucker

Should You Buy Equipment Before Year-End to Save Taxes?

As the fourth quarter launches, an interesting phenomenon occurs in the business world. Equipment dealers get busy, business owners review their profits, and accountants begin hearing a familiar question: “Should I buy more equipment before year-end to save on taxes?” It is a reasonable question, especially after a profitable year. After all, nobody enjoys writing a large check to the IRS. But before purchasing that new truck, machine, or expensive piece of equipment, consider a more important question: Are you buying it because your business needs it, or because you want a tax deduction? The difference could be worth a lot.

The $100,000 Tax Deduction That Still Costs $70,000

Imagine your manufacturing business expects $400,000 in taxable income this year. Your equipment dealer offers a new $100,000 machine, and you learn that the entire purchase may qualify for an immediate tax deduction. Suddenly, spending $100,000 sounds like a wonderful way to save money!

But consider the mathematics. Assuming a combined federal and state marginal tax rate of 30%, a $100,000 deduction could save approximately $30,000 in income taxes. That sounds attractive until you remember that you still spent $100,000. Your business has effectively invested $70,000 after taxes.

If the equipment increases productivity, reduces labor costs, or creates additional revenue, it may be an excellent investment. But if it sits collecting dust, you haven’t saved $30,000. You’ve unnecessarily spent $70,000. A tax deduction makes a good investment better. It doesn’t make a bad investment good.

Section 179 and Bonus Depreciation: Two Valuable Opportunities

Fortunately, federal tax law provides generous incentives for businesses investing in equipment. Two important provisions are Section 179 expensing and bonus depreciation, which may allow businesses to deduct qualifying purchases immediately rather than depreciating them over several years.

For 2026, the federal Section 179 deduction limit is $2,560,000, with the deduction beginning to phase out when qualifying purchases exceed $4,090,000. Section 179 is also subject to a business taxable income limitation. Additionally, current federal law generally allows 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. Unlike Section 179, bonus depreciation can potentially create or increase a tax loss.

However, not every asset qualifies, and state tax treatment may differ from federal rules. Another important distinction is that purchasing equipment is not necessarily the same as placing it in service. Generally, equipment must be ready and available for its intended business use before year-end to qualify for that year’s depreciation deduction. Ordering equipment in December that doesn’t become operational until January may delay the deduction.

Can You Finance Equipment and Still Deduct the Purchase?

Here is an opportunity many business owners overlook. Qualifying financed equipment may generate depreciation deductions based on its eligible purchase price, not merely the cash paid upfront. Suppose your business purchases a $150,000 machine with a $30,000 down payment and finances the remaining $120,000. If the machine qualifies for 100% bonus depreciation, you may receive a $150,000 federal deduction despite paying only $30,000 initially.

That can be an attractive cash flow advantage. However, remember that loan payments continue long after the initial deduction. Loan principal repayments generally aren’t deductible, although qualifying interest may be. The lesson? Tax deductions can improve today’s cash flow, but financing decisions must make sense for the future.

The Question That Matters Most: What Will This Equipment Earn?

Consider a cabinet manufacturer purchasing a $120,000 automated machine. Management estimates annual labor savings of $25,000, material savings of $10,000, and another $15,000 in contribution margin from increased production. That’s potentially $50,000 in annual financial benefits before additional operating costs.

Now we’re talking about an investment that could substantially improve profitability. The equipment isn’t simply reducing taxes; it’s improving efficiency, strengthening competitiveness, and generating future cash flow.

Contrast that with purchasing a $90,000 truck when your existing vehicle works perfectly well. If the replacement creates little additional economic value, the deduction may not justify the expense.

Before purchasing equipment, ask: Will it increase revenue? Reduce costs? Improve quality? Strengthen productivity? And how quickly will the investment pay for itself?

Prudent business owners don’t purchase equipment merely to reduce taxable income. They purchase equipment to increase economic value.

Sometimes the Biggest Deduction Isn’t the Best Deduction

Here’s something that surprises business owners: Taking the largest possible deduction this year doesn’t always produce the greatest lifetime tax savings. Suppose your business experienced a slower 2026 but anticipates substantially higher profits in 2027 and 2028. Depending on your tax situation, spreading deductions into future years could produce greater overall savings if future income faces higher marginal tax rates.

Tax brackets, qualified business income deductions, business losses, state taxes, and future equipment sales can all influence the optimal strategy. Section 179 and bonus depreciation offer certain planning elections, making it worthwhile to compare alternatives before filing.

Effective tax planning isn’t simply about minimizing this year’s taxes. It’s about maximizing long-term after-tax financial results.

Don’t Save Taxes Today and Create a Cash Crisis Tomorrow

A business can be highly profitable and still struggle financially because too much cash is tied up in equipment, inventory, or receivables. Before making a major purchase, consider your upcoming payroll, debt obligations, inventory requirements, and working capital needs. Will the purchase leave sufficient financial flexibility for unexpected expenses or growth opportunities? There is little satisfaction in saving $25,000 in taxes if your business struggles to meet a $50,000 payroll obligation three months later.

This is why October and November are excellent months for tax projections and capital investment planning. Evaluating alternatives early allows time to arrange financing, confirm equipment availability, and determine whether a purchase genuinely supports your financial objectives.

The Bottom Line: Buy Equipment to Make Money, Not Just Save Taxes

The smartest business owners understand that tax savings are an important consideration, but rarely the primary reason for investing capital. A great equipment purchase improves productivity, strengthens profitability, generates cash flow, and builds long-term business value. The tax deduction is an added benefit. Before signing your next equipment purchase agreement, ask one powerful question: “If there were no tax deduction, would this still be a good investment for my business?”  If the answer is yes, the tax deduction may make an already excellent decision even better. If the answer is no, reconsider. After all, business success isn’t measured by how much tax you avoid. It’s measured by the wealth you create, the cash flow you generate, and the financial strength of the business you build.