The Social Security tax started in 1937 to pay for Social Security benefits for retired people. The idea was that today’s workers would pay into the system to provide benefits for current retirees, and then when today's workers retired, there would be new future workers who would be paying into the system to provide benefits for the now-retired workers. Also known as the Old Age, Survivors and Disability Insurance Tax, sometimes abbreviated OASDI on your pay stubs, the tax starts out at just 1 percent of employee income. Today, the tax is much higher than it was in 1937, and it applies to both employee income and self-employment income.
Social Security Tax Rates
The Social Security tax rate is 12.4 percent as of 2018. However, when you work as an employee, the Social Security tax is paid half by you and half by your employer. So, on your paychecks, you’ll see 6.2 percent taken out of your wages for Social Security taxes and your employer chips in the other 6.2 percent. You can calculate the Social Security tax on your employee income by multiplying your total employee income, including bonuses, by 0.062. For example, if your salary is $62,000, you would see $3,844 withheld for Social Security tax, and your employer would pay that same amount on your behalf for the employer portion of the Social Security tax.
If you’re self-employed, you’re required to pay the entire tax by yourself because you’re both the employer and the employee. As a result, you need to budget to pay the entire tax by yourself. But, the tax only applies to your net self-employment income, rather than your gross receipts. For example, if you sell items online, you might have proceeds of $100,000, but if the items cost you $60,000 to obtain, plus another $5,000 in advertising costs, you would only have a net self-employment income of $35,000.
However, to make things equal between employees and self-employed people, only 92.35 percent of your self-employment income is subject to the Social Security tax (and the Medicare tax) to make up for the fact that employees don’t have to pay income taxes on the amounts the employer pays on their behalf for payroll taxes. In addition, self-employed taxpayers can claim an income tax deduction equal to the portion of the self-employment taxes that the employer would have paid when figuring their income taxes. You can claim this deduction as an adjustment to income, so you receive credit for it even if you don’t itemize your deductions when you file.
For example, if you have $62,000 in net self-employment income, multiply $62,000 by 0.9235 to get $57,257. Then, multiply $57,257 by 0.124 to find you would pay $7,099.87 for the Social Security tax portion of self-employment taxes. But, you would also be able to claim a $3,549.93 income tax deduction for the employer portion on your income tax return
Understanding the Contribution and Benefit Base
Each year, you only pay the Social Security tax on your earned income up to a maximum amount of earned income, known as the contribution and benefit base. The amount updates every year for inflation. For example, in 2018, the contribution and benefit base is $128,400, up $1,200 from 2017. For example, if your salary is $150,000, you would only pay the Social Security tax on the first $128,400. As a result, the maximum Social Security tax for the year is $15,921.60 if you’re self-employed or $7,980.80 if you’re an employee.
If you’re married, the contribution and benefit base applies separately to your income and your spouse’s income. For example, say your salary is $140,000 and your spouse is self-employed and earns $50,000 per year. You don’t have to pay the Social Security tax on the last $11,600 of your salary because it’s over the contribution and benefit base amount, but your spouse must pay the Social Security tax on his or her entire earnings because the earned income is entirely under the contribution and benefit base.
The contribution and benefit base limit does not apply to the other portion of the payroll tax, the Medicare tax. So, even if a portion of your wages are not subject to the Social Security tax because those amounts are in excess of the annual contribution and benefit base, you will still pay the Medicare tax on that income.
Ordering Multiple Streams of Income
If you have both employee income and self-employment income and the total income exceeds the amount of the contribution and benefit base for the year, it makes a significant difference to your after-tax income as to whether the Social Security taxes are paid first on employee income, which splits the tax between you and your employer, or self-employment income, where the Social Security tax comes completely out of your pocket.
As a rule, your employee income is counted first when calculating the Social Security tax. That way, you minimize the amount of your self-employment income that is subject to the Social Security tax. For example, say you have a salary of $115,000 and make another $40,000 from your side hustle. Your total income of $155,000 exceeds the 2018 contribution and benefit base of $128,400 by $26,600. Under the ordering rules, the Social Security tax is collected first from your $115,000 salary, where you pay 6.2 percent and your employer chips in the other 6.2 percent. Only after exhausting all of your employee income will the Social Security tax apply to the next $13,400 of your self-employment income, where you pay the entire 12.4 percent tax. But, the final $26,600 of your self-employment income escapes the Social Security tax.
If you work as an employee in multiple jobs, each job will collect Social Security tax on all of your wages up to the annual contribution and benefit base, even if your total income for the year exceeds the contribution and benefit base. However, you can claim an excess withholding over the annual maximum as a tax credit when you file your income tax return, so you’ll receive the excess back in the form of a tax refund.
For example say that one job pays you a salary of $103,400 and another job pays you $35,000. Combined, you have $138,400 of employee income for the year. If this were from one job, your employer would simply stop collecting the Social Security tax once you passed the annual contribution and benefit base of $128,400. However, because you won’t exceed that threshold at either job alone, each job will withhold the Social Security tax from your entire paycheck and as a result you’ll have Social Security taxes withheld on an extra $10,000 of income. But, you’ll get that excess back when you file your income tax return at the end of the year.
Understanding Exempt Income
The Social Security tax only applies to your earned income, such as wages, bonuses and self-employment income. All of your unearned income, like capital gains, interest and dividends, are exempt from the Social Security tax, regardless of how much income you have. For example, if you were an early investor in Apple and sold your shares for a $100,000 profit, you would pay income taxes, but not Social Security taxes, on that $100,000 gain. So, today’s capital gains and Social Security benefits you receive in retirement don’t affect each other.
There is also an exemption for students working at the school that they attend. As long as the primary relationship between the student and school is educational, the student’s wages from working at the school are exempt from the Social Security and Medicare taxes. For example, if you are a full-time student at a university and you work in the library part time as part of a work-study program, or you assist one of your professors with research, your wages are exempt from the Social Security and Medicare taxes. However, if you are a full-time coach at the school and you take a class or two each semester on the side, you won’t get out of having your wages hit with the Social Security and Medicare tax.
Another exception from the Social Security tax is employer contributions to a qualified retirement plan on your behalf. For example, if your company contributes money, either automatically or as a matching contribution, directly to your 401(k) plan, that money isn’t subject to the Social Security or Medicare tax. However, any money that you contribute to your 401(k) plan is still subject to the payroll taxes. So, if you make a $9,000 contribution to your 401(k) plan and your employer matches the first $5,000, you’ll still have the Social Security tax applied to the $9,000 contribution you made, but not the $5,000 contribution your employer made for you.
Finally, you are also exempt from paying the Social Security tax on employer-paid health insurance premiums. For example, if your employer pays $340 per month for your health insurance, you don’t have to pay Social Security taxes on that $340 worth of fringe benefits. However, other fringe benefits are still subject to FICA taxes.
Significance of Paying Social Security Taxes
Paying into Social Security allows you to qualify to receive Social Security benefits in your later years. If you haven’t paid in enough over time, you won’t qualify to receive any benefits. To qualify, you need to have at least 40 retirement credits. Each year that you work, you can earn up to four credits based on your income. In 2018, you earn one credit for every $1,320 in earnings subject to the Social Security tax.
However, you don’t want to stop when you’ve reached your four credits per year, or 40 credits over your lifetime. That’s because the Social Security Administration calculates your monthly benefit amounts based on your 35 highest earning years, as determined by the amount of wages you paid Social Security taxes on. The more you made during those years, the higher your monthly benefits will be. Your wages each year are multiplied by an index factor to account for inflation since that year. That way, income you earned 30 or more years ago won’t be rendered worthless by inflation in your calculations.
Credits also qualify you to receive Social Security disability benefits. The minimum number of credits you need to receive Social Security disability benefits depends on your age. If you’re under 24 years old, you can qualify if you’ve earned at least six credits in the three years prior to your injury. If you’re between 24 and 31 years old, you need to average at least two credits per year since you turned 21. For example, if you’re 28, you would need at least 14 credits because that’s half of the maximum of 28 credits you could have earned in the seven years since you turn 21. If you’re between 31 and 42, you need at least 20 credits, and then each year you are older than 42, you need an additional credit to qualify for Social Security disability benefits.
- Social Security Administration: FICA and SECA Tax Rates
- Social Security Administration: Retirement Benefits
- Social Security Administration: Contribution and Benefit Base
- IRS: Employee Benefits
- Social Security Administration: Credits
- Social Security Administration: Your Retirement Benefit: How It’s Figured
- IRS: Student Exception to FICA Tax