What Is Social Security Tax? Definition, Exemptions, and Example

What Is the Social Security Tax?

Social Security tax is the tax levied on both employers and employees to fund the Social Security program in the U.S. 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.

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 2022, 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. 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 2022, the Social Security tax is taken from income up to an annual limit of $147,000; any amount earned above that is not subject to Social Security tax. The limit for 2023 is $160,200.

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 the Medicare tax. As of 2022, 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 $147,000 (limit) = $22,491.

Ike can claim an above-the-line deduction for half of his self-employment tax, or $22,491÷ 2 = $11,245.5. In effect, he gets a partial refund on the employer portion (6.2% Social Security + 1.45% Medicare = 7.65%) of his self-employment tax.

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 2022 and has a 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 for the tax year 2022. The Social Security tax rate will only be applied up to the limit of $147,000.

Therefore, Jacob will pay 6.2% x $147,000 = $9,114 as his contribution to the country’s Social Security account for older people and people with disabilities, but his effective Social Security tax rate is $9,114 ÷ $175,000 = 5.2%. Izzy, with a lower income per annum, is effectively taxed at 6.2% (i.e., $5,270 ÷ $85,000).