What is a Social Security Tax
A Social Security tax is the tax levied on both employers and employees to fund the Social Security program. Social Security tax is usually collected in the form of payroll tax or self-employment tax. The Social Security tax pays for the retirement, disability, and survivorship benefits received by millions of Americans each year.
Also known as Old Age, Survivors, and Disability Insurance (OASDI).
BREAKING DOWN Social Security Tax
The Social Security tax is applied to income earned by employees and self-employed taxpayers. Employers usually withhold this tax from the 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 system, but rather are used to pay existing retirees. 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.
As of 2017, the Social Security tax rate is 12.4%. Half of the tax is paid by the employer, and the employee is responsible for paying the other half, that is 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 2017, the Social Security tax is taken from income up to an annual limit of $127,200. Any amount earned above $127,200 is Social Security tax-free.
Consider two employees, Jacob and Izzy. Izzy earns $85,000 for the tax year 2017 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 $127,200. Therefore, Jacob will pay 6.2% x $127,200 = $7,886.40 as his contribution to the country’s Social Security account for retirees and the disabled.
The Social Security tax is a regressive tax scheme, meaning that lower income earners get a larger portion of their total income withheld, compared to higher income earners. Jacob earns $175,000 per year but only pays $7,886.40 for Social Security. His effective Social Security tax rate is, therefore, $7,886.40 ÷ $175,000 = 4.51%. Izzy, with a lower income per annum, is effectively taxed at 6.2% (i.e. $5,270 ÷ $85,000). Even households that earn a certain level of income to which little to no federal income tax will be applied, may still have Social Security tax taken. For example, a single taxpayer that earns $10,000 gross income in a given year will have zero income tax liability, however, 6.2% may still be taken for Social Security.
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, s/he has 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, and as of 2017, the self-employment tax is 15.3% = 12.4% Social Security tax + 2.9% Medicare Tax. The self-employment tax is only applied on 92.35% of net business earnings.
Ike, who runs a HR 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 $127,200 (limit) = $19,461.60. Ike can claim an above-the-line deduction for half of his self-employment tax, or $19,461.60 ÷ 2 = $9,730.80. In effect, he gets a refund on the employer portion (6.2% Social Security + 1.45% Medicare = 7.65%) of his self-employment tax.
Not every taxpayer has to pay the Social Security tax though. Exemptions from the Social Security tax are available to a specific group 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, or 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 US for a foreign government.
- Students who are employed at the same school they are enrolled at, and where employment is contingent on continued enrollment.
Please refer to the IRS website for more information on Social Security tax and exemptions.