If you are self-employed and you claim early retirement benefits from Social Security (any time between age 62 and your full retirement age), your benefits may be reduced if you're performing "substantial services," even if you're not making income over the allowed limits. (Until you reach full retirement age, Social Security will subtract money from your retirement check if you exceed a certain amount of earned income for the year. For the year 2021, this limit on earned income is $18,960. (Read more in Nolo's article on working while collecting Social Security.)
The reason Social Security has a special rule for small business owners is that some people with their own businesses try to get around the income limit by continuing to work and paying a relative instead of themselves, or by continuing to run the business but being paid only for reduced work time to stay under the limit. (This is true even though any reductions taken from your retirement benefits for working are paid back to you over a 10-15 year period after you reach full retirement age. For more information, read our article on the penalty for working and collecting early retirement.)
The rule is that if you are self-employed, you can receive full benefits for any month in which you Social Security considers you retired. To be considered retired, you must not have earned over the income limit and you must not have performed what Social Security considers substantial services.
The usual test for substantial services is whether you worked in your business more than 45 hours during the month, subject to some exceptions. For instance, if you worked between 15 and 45 hours per month and the work you did could be considered highly skilled, your work could be considered substantial services (more on this below). But if you worked less than 15 hours, in no case will you be considered to have performed substantial services (you are considered retired, period).
When considering when services are substantial, Social Security will look at the following factors:
As mentioned above, if you worked between 15 and 45 hours in a month and the work you did could be considered highly skilled, your work will likely be considered substantial services. But where a person works from 15 through 45 hours in a month and can establish that the services were not substantial, the person can be considered retired. Services can be considered not substantial if both of the following are true.
The actual earnings limit varies depending on whether you'll reach full retirement in that year. You'll be considered retired this year if either of the following is true.
Social Security may require some extra information from you to prove you are not earning too much income or performing substantial services. The agency will want to see evidence that you are really giving up full-time work and not merely shifting your pay to someone else. Social Security is likely to ask for information regarding your continuing involvement with your own business if:
Social Security may ask for such documents as the business's pay and personnel records, personal and business tax returns, stock transfer agreements, and business expense records. Try to contact your local Social Security office several months in advance of applying for early retirement benefits so that you'll learn what documents Social Security wants and have time to gather the documents.
If Social Security determines that you provide services to the business with a value that exceeds the amount you are paid—based on the time you spend, the level of your responsibility, and the value of services you provide—Social Security may attach a dollar value to those services. If this dollar value, plus what you are actually earning, exceeds the amount of earned income permitted for your age, your benefits may be reduced.
Social Security will request earnings estimates from individuals who are receiving early retirement and receive substantial self-employment income or income that varies widely from month to month. Toward the end of each year, Social Security sends those people a form asking for an earnings estimate for the following year. The information you submit will be used to calculate your retirement benefits for the first months of the following year, until they are adjusted with your actual self-employment tax information.
Once you reach full retirement age, you will no longer need to do this since there is no Social Security limit on how much a person can work or earn after reaching full retirement age.
This article was based on an excerpt from Social Security, Medicare & Government Pensions, by Joseph Matthews (Nolo).
Updated January 5, 2023