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.

Exemptions

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.

RELATED TERMS
  1. Social Security Benefits

    Social security benefits are funds that are received by retired ...
  2. Social Security Trust Fund

    The Social Security Trust Fund refers to two accounts used by ...
  3. Self-Employed Person

    A self-employed person is an independent contractor or sole proprietor ...
  4. Social Capital

    Social capital is the economic resources obtained from interactions ...
  5. Federal Insurance Contributions ...

    Federal Insurance Contributions Act (FICA) is a US payroll tax ...
  6. Social Enterprise

    An organization that is directly involved in the sale of goods ...
Related Articles
  1. Retirement

    Is there a way to opt out of Social Security?

    Understand more about the purpose of the Social Security system and learn which groups of taxpayers are automatically exempt from the tax.
  2. Taxes

    How Fixed Income Threshold Reduces Social Security Benefits

    The use of fixed income threshold amounts to an ongoing tax increase and a means test on Social Security beneficiaries. Here's how.
  3. Retirement

    Who Pays Your Social Security Benefits?

    The short answer is, current earners. Taxes on current wages pay the Social Security benefits of retirees, the disabled, children and other beneficiaries.
  4. Retirement

    Introduction to Social Security

    You've probably contributed to this fund, but will you reap the benefits? Find out here.
  5. Retirement

    12 Million to Pay More Social Security Tax in 2017

    2017 may be a year of tax cuts, but there's at least one exception.
  6. Retirement

    Social Security, Taxes and Retirement Withdrawals

    Social Security, taxes, and the right order to withdraw your retirement income are all related.
  7. Retirement

    An Analysis Of Social Security Benefits And Their Future

    Social Security is a significant driver of the US economy--as good a reason as any to make sure you understand it!
  8. Retirement

    The Purpose of a Social Security Statement

    Learn what information your Social Security benefit statement contains and how you can use the information to more intelligently plan for retirement.
  9. Retirement

    Create Your Own Social Security Fund

    The government's Social Security program may not last forever - be prepared by setting up your own.
Hot Definitions
  1. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  2. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  3. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  4. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  5. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center