What Is the Social Security Tax?
Social Security tax is the tax levied on both employers and employees to fund the Social Security program. Social Security tax is collected in the form of a payroll tax mandated by the Federal Insurance Contributions Act (FICA) or a self-employment tax mandated by the Self-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 in the U.S.
- Social Security taxes fund the retirement, disability, and survivorship benefits that millions of Americans receive each year from the Social Security Administration.
- In 2021, the Social Security tax rate is 12.4%, divided evenly between employers and employees, on a maximum wage base of $142,800.
- 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 retirees 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 widow or widower upon the death of a spouse or to a dependent child upon the death of a parent.
As of 2021, the Social Security tax rate is 12.4%. Half of the tax, or 6.2%, is paid by the employer, and the employee is responsible for paying the other half, or 6.2%. 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 to which the tax rate is applied. For 2021, the Social Security tax is taken from income up to an annual limit of $142,800. Any amount earned above $142,800 is not subject to Social Security tax.
Social Security Tax for the Self-Employed
Social Security tax is also taken from the earnings of the self-employed. 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. The Social Security tax is applied to all net earnings up to the wage limit. The self-employment tax is made up of the Social Security tax and Medicare tax. As of 2021, the self-employment tax is 15.3% (12.4% Social Security tax + 2.9% Medicare Tax). The self-employment tax is only applied to 92.35% of net business earnings.
Here's an example: Ike, who runs a human resources consulting business, calculates his total net income for the year to be $200,000 after business expenses have been deducted. His self-employment tax rate will be assessed on 92.35% x $200,000 = $184,700. Since this amount is above the capped limit, his tax bill will be 15.3% x $142,800 (limit) = $21,848.40. Ike can claim an above-the-line deduction for half of his self-employment tax, or $21,848.40 ÷ 2 = $10,924.20. In effect, he gets a refund on the employer portion (6.2% Social Security + 1.45% Medicare = 7.65%) of his self-employment tax.
Social Security tax is a regressive tax, which takes a larger percentage of income from low-income earners than from their high-income counterparts.
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.
Examples 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 to that of higher-income earners. Consider two employees, Izzy and Jacob. Izzy earns $85,000 for the tax year 2020 and has 6.2% Social Security tax withheld from his pay. The federal government, in effect, collects 6.2% x $85,000 = $5,270 from Izzy to help pay for retirement and disability benefits.
Jacob, on the other hand, earns $175,000. The Social Security tax rate will only be applied up to the limit of $142,800. Therefore, Jacob will pay 6.2% x $142,800 = $8,853.60 as his contribution to the country’s Social Security account for retirees and the disabled, but his effective Social Security tax rate is $8,853.60 ÷ $175,000 = 5.05%. Izzy, with a lower income per annum, is effectively taxed at 6.2% (i.e., $5,270 ÷ $85,000). Even households that earn a level of income to which little to no federal income tax will be applied may still have Social Security tax taken from their pay. A single taxpayer who earns $10,000 gross income in a given year, for example, will have zero income tax liability, but 6.2% may still be taken for Social Security.