Social Security and Medicare payroll withholding are collected as the Federal Insurance Contributions Act (FICA) tax. It is 12.4% of earned income up to an annual limit that must be paid into Social Security and an additional 2.9% that must be paid into Medicare. Therefore, if you are a waged or salaried employee, half of the payroll tax—6.2% for Social Security and 1.45% for Medicare—is automatically withheld from each paycheck, and your employer contributes the other half.
On the other hand, if you are self-employed, you are responsible for the entire amount (12.4% for Social Security plus 2.9% for Medicare, for a total of 15.3%), but you can generally deduct half of the FICA tax on your federal income tax return. This is true for any self-employed person earning more than $400 per year and is reported on IRS Form 1040 Schedule SE.
- Income tax caps limit do not apply to Medicare taxes, but Social Security taxes have a wage-based limit.
- The cap limits how much high earners need to pay in Social Security taxes each year.
- Critics argue that income tax caps unfairly favor high earners compared to low-income earners.
- Others believe that raising the cap would result in one of the largest tax hikes of all-time.
Understanding Income Caps
There is no income cap (or wage base limit) for the Medicare portion of the tax, meaning you continue to owe your half of the 2.9% tax on all wages earned for the year, regardless of the amount of money you make.
The Social Security tax, however, has a wage-based limit, which means there is a maximum wage that is subject to the tax for that year, and, beyond that, there are no more taxes to pay.
For 2021, the wage base limit for Social Security taxes increased to $142,800, a $5,100 increase from $137,700 in 2020. That means up to $8,853.60 (6.2%) can be withheld from your paycheck for Social Security taxes for the year, but not more, regardless of how much you earn.
When President Roosevelt presented his plan for Social Security, it did not include an income cap. The original plan exempted high earners from Social Security altogether—including both taxes and benefits—and anyone who made more than $3,000 per year was supposed to be left out of the system completely.
As FDR's plan worked its way through Congress, the exemption for high earners was eliminated, and the House Ways and Means Committee replaced it with a $3,000 cap. Historians on the subject have found no evidence supporting why the committee chose an earnings cap over an exemption, but it has been in place ever since. It has risen at the same rate as wages in the economy since 1982.
Advantages and Disadvantages of Income Caps
The cap on wages subject to the tax is the subject of controversy, partly because it means that, while the average worker pays tax on every dollar of their income (the vast majority of workers earn less than the wage base limit), the highest earners pay tax on only part of their income. Critics argue that caps on FICA taxes are not fair for that reason.
Meanwhile, some people believe that lifting the cap would result in a significant amount of revenue that could help cover the shortfall Social Security will soon face. However, opponents of this idea claim that increasing the cap would result in one of the largest tax increases of all time.