As the anniversary of the Social Security bill being signed into law (August 14, 1935)1 approaches, we’re reminded of the intricate workings of the US tax system. Social Security, a vital program designed to provide financial support to retired and disabled individuals, is funded through payroll taxes.2 Let’s explore the fundamentals of Social Security taxation, shedding light on how it works and its implications for both employees and employers.
The Federal Insurance Contributions Act (FICA): Social Security taxation is governed by the Federal Insurance Contributions Act (FICA). Under FICA, employees and employers must contribute a portion of their income to fund Social Security and Medicare programs. These contributions are collectively known as payroll taxes.3
Social Security Tax: The Social Security tax, a component of FICA, is specifically earmarked to fund retirement, disability, and survivorship benefits. From 2020 - 2023, the Social Security tax rate stands at 6.2% for both employees and employers.4 This means that employees contribute 6.2% of their income, while employers match that amount.
Earnings Subject to Social Security Tax: There is a cap on the earnings subject to Social Security taxation. In 2023, the maximum taxable earnings limit is set at $160,200.5 This means that any income earned above this threshold isn't subject to Social Security tax. However, being aware of this limit is essential as it can affect your tax liability and retirement benefits.
Self-Employment Tax: The Social Security and Medicare taxes are combined into a single self-employment tax for self-employed individuals. The self-employment tax rate for Social Security is 12.4% (double the rate for employees), and the Medicare tax rate remains 2.9%.6 However, self-employed individuals can deduct the employer portion of these taxes when calculating their adjusted gross income.7 Self-employed individuals have additional responsibilities when it comes to Social Security taxation. They must calculate and pay the employer and employee portions of the self-employment tax, making proper estimation and planning crucial.
Disclaimer : The above are not inclusive of all Social Security tax considerations but merely a glimpse into some.
Understanding the intricacies of Social Security taxation is crucial for the sake of your retirement benefits. By comprehending the fundamentals, contribution rates, and limits, individuals can better plan for their financial future and make informed decisions about their tax obligations. While navigating the tax system can be complex, staying informed and seeking professional advice can help optimize retirement benefits.