What Is the Social Security Tax?
The Social Security tax is the tax levied on employers and employees to fund the Social Security program in the U.S. The revenue is collected in the form of a payroll tax mandated by the Federal Insurance Contributions Act (FICA) or a self-employment tax mandated by theSelf-Employed Contributions Act (SECA).
The Social Security tax pays for the retirement, disability, and survivorship benefits that millions of Americans receive each year under the Old-Age, Survivors, and Disability Insurance (OASDI) program—the official name for Social Security.
Key Takeaways
- Social Security taxes fund the retirement, disability, and survivorship benefits that millions of Americans receive each year from the Social Security Administration.
- The Social Security tax rate is 12.4%, and is divided evenly between employers and employees, on a maximum wage base of $160,200 ($168,600 in 2024).
- Self-employed individuals pay the employer and employee portions of Social Security tax, but only on 92.35% of net business earnings.
- Certain groups, including some nonresident aliens and members of religious groups with specific views, are exempt from paying Social Security tax.
How the Social Security Tax Works
The Social Security tax is applied to income earned by employees and self-employed taxpayers. Employers usually withhold this tax from employees’ paychecks and forward it to the government.
The funds collected from employees for Social Security are not put into a trust for the individual employee currently paying into the fund, but rather are used to pay existing older people in a "pay-as-you-go" system.
Social Security tax is also collected to support individuals who are entitled to survivorship benefits—benefits paid to a surviving spouse upon the death of a spouse or to a dependent child upon the death of a parent.
As of 2023, the Social Security tax rate is 12.4%. Half of the tax, or 6.2%, is paid by the employer, and the other 6.2% is paid by the employee. The Social Security tax rate is assessed on all types of income earned by an employee, including salaries, wages, and bonuses.
However, there is an income limit above which the tax cannot be applied. For 2023, that annual limit is $160,200. The limit for 2024 is $168,600.
Social Security Tax for the Self-Employed
Social Security tax is also applied to the net earnings of the self-employed, up to that aforementioned income limit. Since the Internal Revenue Service (IRS) considers a self-employed individual to be both an employer and an employee, they have to pay the full 12.4% Social Security tax themself.
The self-employment tax is made up of the Social Security tax and the Medicare tax. As of 2023, the self-employment tax is 15.3% (12.4% Social Security tax + 2.9% Medicare tax). The tax is only applied to 92.35% of net business earnings.
Here's an example of how it works:
Ike, who runs a human resources consulting business, calculates his total net income for 2023 to be $200,000 after business expenses have been deducted. His self-employment tax rate will be assessed on 92.35% of $200,000, or $184,700 (.9235 x $200,000).
However, since this amount is above the $160,200 income limit, his tax bill actually will be 15.3% of $160,200, or $24,510.60 (.153 x $160,200).
Ike can claim an above-the-line deduction for half of his self-employment tax, or $12,255.30 ($24,510.60 ÷ 2). In effect, he gets a partial refund on the 7.65% employer portion of his self-employment tax (6.2% Social Security + 1.45% Medicare) .
The U.S. Social Security program provides Americans with some financial protection from earnings lost due to retirement, death, or disability. Retired workers, their families, and survivors of deceased workers receive monthly benefits payments. Social Security is funded mainly by the taxes employees, their employers, and self-employed individuals pay throughout their working years.
Exemptions
Not every taxpayer has to pay Social Security tax. Exemptions are available to specific groups of individuals, including:
- Members of a religious group who are opposed to receiving Social Security benefits during retirement, if disabled, or after death
- Nonresident aliens—that is, individuals who are neither citizens nor legal residents of the United States, who are in the country temporarily as students
- Nonresident aliens working in the U.S. for a foreign government
- Students who are employed at the same school where they are enrolled, and where employment is contingent upon continued enrollment
Example of Social Security Taxes
The Social Security tax is a regressive tax, meaning that a larger portion of lower-income earners' total income is withheld, compared with that of higher-income earners.
Consider two employees, Izzy and Jacob. Izzy earns $85,000 for the tax year 2023 and has the 6.2% Social Security tax withheld from his pay. The federal government collects $5,270 (.062 x $85,000) from Izzy to help pay for retirement and disability benefits.
Jacob, on the other hand, earns $175,000 for the tax year 2023. The Social Security tax rate will only be applied up to the limit of $160,200.
Therefore, Jacob will pay $9,932.40 (.062 x $160,200) as his contribution to the country’s Social Security program for older people, survivors, and people with disabilities. But his effective Social Security tax rate is 5.7% ($9,932.40 ÷ $175,000). Izzy, with a lower income per annum, is taxed at the higher 6.2% rate ($5,270 ÷ $85,000).
What Is the 2023 Social Security Tax Limit?
In 2023, the income limit for Social Security tax is $160,200 (for 2024, it's $168,600). That means employees will not have to pay tax on any amount they earn above $160,200.
How Can I Avoid Paying Taxes on Social Security?
If you earn in retirement between $25,000 and $34,000 and file as an individual, you may have to pay up to 50% in taxes on your Social Security benefits. If you earn more than $34,000, you may have to pay up to 85%. To minimize the tax, you can earn less, move income-generating assets into an IRA, minimize withdrawals from retirement plans, or donate your required minimum distribution.
At What Age Is Social Security Not Taxable?
Social Security is always taxable, regardless of age. Your income in any given year determines whether or not your Social Security benefits are taxed.
The Bottom Line
The Social Security tax (currently at a rate of 12.4%) is applied to the earned income of Americans throughout their working years. The revenue derived from the Social Security tax funds the Old-Age, Survivors, and Disability Insurance (OASDI) program commonly known as Social Security.
The Social Security program, established in 1935, provides monthly financial benefits to workers when they reach retirement age, as well as to survivors of deceased workers (e.g., a spouse or child), and disabled workers.
As a seasoned expert in tax policies and government programs, particularly the Social Security system in the United States, I bring a wealth of knowledge and experience to shed light on the intricacies of the Social Security tax. My expertise is grounded in an in-depth understanding of the Federal Insurance Contributions Act (FICA) and the Self-Employed Contributions Act (SECA), the legislative frameworks that mandate the collection of Social Security taxes.
Let's delve into the core concepts discussed in the article:
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Social Security Tax Overview:
- The Social Security tax is a crucial component of the U.S. Social Security program, designed to fund retirement, disability, and survivorship benefits.
- Revenue is collected through a payroll tax, either under FICA for employees or SECA for self-employed individuals.
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Tax Rates and Wage Base:
- The Social Security tax rate is 12.4%, evenly split between employers and employees.
- The tax is applied to a maximum wage base, which was $160,200 in 2023 and increased to $168,600 in 2024.
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Self-Employed Individuals:
- Self-employed individuals are subject to the full 12.4% Social Security tax and an additional 2.9% Medicare tax, making up a total self-employment tax of 15.3%.
- The tax is applied to 92.35% of net business earnings, with an income limit similar to that of employees.
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Example Calculation for Self-Employed Individuals:
- An illustrative example involves a self-employed individual named Ike, who calculates his self-employment tax based on his net business earnings and the income limit.
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Exemptions from Social Security Tax:
- Certain groups, such as nonresident aliens, members of specific religious groups, nonresident aliens working for foreign governments, and students employed at the same school, are exempt from paying Social Security tax.
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Regressive Nature of Social Security Tax:
- The Social Security tax is regressive, meaning a higher percentage of income is withheld from lower-income earners compared to higher-income earners.
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Social Security Tax Limits and Avoidance:
- The income limit for Social Security tax in 2023 is $160,200 (increased to $168,600 in 2024).
- Strategies to minimize Social Security tax include managing retirement income and strategically positioning assets.
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Taxation of Social Security Benefits:
- Social Security benefits are taxable, with the tax rate depending on the individual's income level.
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Permanence of Social Security Tax:
- Contrary to a common misconception, Social Security benefits are always taxable, regardless of the recipient's age.
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Historical Context:
- The Social Security program was established in 1935 and plays a vital role in providing financial benefits to retired workers, survivors, and disabled individuals.
In conclusion, the Social Security tax is a multifaceted aspect of the U.S. tax system, intricately woven into the broader Social Security program. Its impact on individuals, whether employees or self-employed, is significant, and understanding its nuances is crucial for informed financial planning.
