Social Security Tax

Social security tax and social security benefits are part of the system where working individuals pay into the social security system in order to receive payments during retirement or other periods when they cannot work. Most working people split the costs of social security with their employers. The self-employed also pay social security tax. Many people recognize this tax as the “FICA” line on their pay stub. This stands for the “Federal Insurance Contributions Act” and the Social Security and Medicare taxes levied under it are used to fund the Social Security system.

Social Security Tax Amounts

Social security tax amounts depend on your wages. On January 1, 2019, employees contribute 6.2% of their wages towards Social Security, up to a payroll tax ceiling of $132,900. If the employer earns more than this threshold amount, no Social Security taxes are paid.  Employers pay a matching 6.2%.

Social security tax for self-employed workers is different. In 2019, you pay 15.3% of your taxable income into the social security and Medicare programs, up to the first $132,900 of net income. You continue to pay 2.9% on the rest of your earnings above the $132,900 threshold. Although the impact on you is greater because you pay twice the rate of employees, you get a break at tax time. You can deduct half of your federal self-employment taxes from your income when it comes time to pay your federal income tax.

Medicare Surtax on Higher Income Individuals

A Medicare tax designed to pay the cost of health care reform (the Affordable Care Act) went into effect on January 2013.  The Medicare tax is an additional 0.9% that applies to wages and self-employment income in excess of $200,000 (single), $250,000 (married), or $125,000 (married but filing separately). The income thresholds are not inflation-adjusted. Withholding of the surtax is required once the employee’s wages exceed $200,000, without regard to the individual’s filing status.  The actual tax due is calculated by taxpayers on their income tax returns.

How Social Security Works

While both Social Security and Medicare programs are payroll taxes, they function differently. For example, there is no maximum income base for Medicare taxes. Every dollar is taxed, whereas Social Security has a maximum wage base of $132,900 in 2019. If you have gross wages from a job and net income from self-employment that equal $132,900 in 2019, this is the maximum income base to which Social Security tax would apply. Medicare taxes would be assessed not only on the $132,900, but also on any amount over $132,900 in 2019.

Social security taxes are collected and placed into two trust funds at the United States Treasury. One is the Old Age and Survivors Insurance (“OASI”) and the other is the Disability Insurance (“DI”) trust fund. The OASI pays for retirement and survivors’ benefits. The DI pays disability benefits. There are also two Medicare trust funds including Hospital Insurance (“HI”) and Supplementary Medical Insurance (“SMI”). Most of your Social Security taxes (5.35 of the total 7.65 percent) go to OASI.

Social Security Benefits: The Role of Trust Funds

The trust funds were set up with the goal of funding current users and setting aside funds to prepare for the future. Any money not used to pay benefits is invested in special U.S. government bonds to build future funds. The goal is for the funds to take in more money than they pay out in order to prepare for the increasing number of retirees. The status of the funds and their future ability to pay Social Security and Medicare benefits has been a source of controversy and potential examination by Congress.

Case Studies: Understanding Social Security Tax and Benefits

Case Study 1: David’s Early Retirement Decision

David, a 62-year-old employee, faces the decision of whether to retire early or continue working. This case study explores the financial implications of social security tax and benefits on David’s early retirement plans, including the impact on his monthly benefits and long-term financial stability.

Case Study 2: Sarah’s Self-Employment Journey

Sarah is a self-employed freelancer who struggles to understand her tax obligations and benefits under the social security system. This case study follows Sarah as she navigates the complexities of social security tax as a self-employed individual, highlighting the importance of proper tax planning and compliance.

Case Study 3: The Impact of Medicare Surtax on a High-Income Couple

Mark and Lisa are a married couple with a combined high income. This case study examines the effects of the Medicare surtax on their financial situation, including the tax liability and adjustments they need to make to their budget and retirement planning.