How is the Social Security tax calculated?

The Old Age, Survivors and Disability Insurance (OASDI) program tax, more commonly called Social Security tax, is calculated by taking a fixed percentage of your income from each paycheck. Social Security tax rates are determined by law each year and apply to both employees and employers.

For both 2021 and 2022, the Social Security tax rate for employees and employers is 6.2% of employee compensation, for a total of 12.4%. The self-employed are responsible for the total 12.4%.

The combined taxes withheld for Social Security and Medicare are known as the Federal Insurance Contributions Act (FICA). On your statement, Social Security taxes are called OASDI and Medicare is shown as Fed Med / EE. Both Social Security and Medicare are federal programs that provide benefits to retirees, people with disabilities, and children of deceased workers.

Key points

  • The Social Security tax rate for both employees and employers is 6.2% of employee compensation (for a total of 12.4%).
  • The Social Security tax rate for those who are self-employed is 12.4% total.
  • There is a limit on the amount of taxable annual wages or earned income, called a tax limit; In 2021, the maximum amount of income subject to Social Security tax is $ 142,800; In 2022, the maximum is $ 147,000.
  • A common complaint with the Social Security tax is that it is regressive, which means that it is applied uniformly regardless of income, unlike a progressive tax, which is based on income.

Social security tax rates

The Social Security program provides benefits to retirees and those who are otherwise unable to work due to illness or disability. Social Security often provides the only source of steady income for people who can no longer work, especially those with a history of modest income.

Because Social Security is a government program intended to provide a safety net for working citizens, it is funded by a simple tax withholding that deducts a fixed percentage of pre-tax income from each paycheck. Workers who contribute for a minimum of 10 years are eligible to receive benefits based on their earnings history once they retire or become disabled.

Social Security benefits are limited to a maximum monthly benefit amount based on earnings history. To prevent workers from paying more in taxes than they can later receive in benefits, there is a limit on the amount of taxable annual wages or earned income, called a tax cap.

For 2021, the maximum amount of income subject to the OASDI tax is $ 142,800, with the maximum annual employee contribution capped at $ 8,853.60. For 2022, the maximum amount of subject income is $ 147,000, with the maximum annual employee contribution capped at $ 9114. The amount is set by Congress and may change from year to year.

The salary cap is indexed for inflation annually and can be found in IRS Publication 15 for most employees or in Publication 51 for agricultural workers. According to IRS Publication 15, wages subject to FICA include all income received for services rendered, unless specifically excluded. Payment does not have to be in cash or by check.

Salaries include wages, bonuses, commissions, and paid vacation or sick leave. Also included are payments in kind, in the form of goods, accommodation, food, clothing or services, unless the employee is a domestic or agricultural worker.

Elective contributions to a qualified retirement plan are also subject to FICA. Accident or health insurance premiums paid by the employer for an employee, including the employee’s spouse and dependents, are not wages and are not included in FICA. Employer contributions to the Health Savings Account (HSA) are also not considered wages.

For example, Jeff makes $ 20,000 a year. He chooses to contribute $ 4,000 to his 401 (k) plan and his employer matches 25%, or $ 1,000. Your Social Security salary is $ 20,000, but your elective deferred contribution is still subject to FICA, and the additional amount contributed by the employer is not. The Social Security tax withheld from your wages is $ 1,240 ($ 20,000 x 6.2%).

If a person earns more than the Social Security tax limit from more than one employer, they may actually pay more taxes than required. When an overpayment occurs, that amount is applied to the individual’s federal tax bill or refunded. Each employer still has to match the tax contribution, but they do not receive a refund even if they realize the overpayment.

History of Social Security tax rates

The Social Security tax began in 1937. At that time, the employee rate was 1%. It has risen steadily over the years, reaching 3% in 1960 and 5% in 1978. In 1990, the proportion of employees increased from 6.06 to 6.2%, but has remained stable since then, with the exception of 2011 and 2012.

The 2010 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act reduced the contribution percentage to 4.2% for employees during those years; employers were still required to pay the full amount of their contributions.

The tax cap has existed since the program began in 1937 and remained at $ 3,000 until the Social Security Amendments Act of 1950. It was then raised to $ 3,600 with expanded benefits and coverage. Additional increases in the tax cap were designed in 1955, 1959, and 1965 to address the difference in benefits between low-wage and high-wage earners.

Social Security’s fiscal policy in the 1970s saw a series of proposed amendments and reevaluations. The Nixon Administration was instrumental in arguing that tax cap increases should be correlated with changes in the national median wage rate in order to address benefit levels for individuals in different tax brackets. The Social Security Amendments Act of 1972 had to be renewed due to problems with the benefit formula that caused financial concerns. A 1977 amendment resolved the financial deficit and established a structure for increasing the tax ceiling that correlated with average wage increases.

In addition to keeping up with average wage increases, the Social Security tax cap has also been increased to improve funding within the system and provide reasonable benefit amounts for those earning higher than average wages.

In the 21st century, a common concern is that Social Security could become insolvent due to increased life expectancy and a reduction in the ratio of workers to retirement. Analysts sometimes suggest raising the Social Security tax as a way to keep the program adequately funded. However, most politicians are hesitant to support this position due to overwhelming public sentiment against it.

A regressive tax

Another common complaint with the Social Security tax is that it is regressive, meaning if a person earns less money, a higher percentage of their income goes to this tax. It is a regressive tax because it only applies to income up to a certain amount. Anyone making less than $ 142,800 in 2021 has an effective Social Security tax rate of 6.2%. Someone making $ 1 million per year, on the other hand, pays a much smaller percentage of their total income for Social Security tax.´╗┐´╗┐

Medicare

The Medicare Hospital Insurance (HI) program is another government program that provides services to citizens in need and requires mandatory tax withholding.

Like the OASDI, the HI tax rate is set each year by law. For 2021, the HI tax rate is 1.45% for employees and employers. Those who are self-employed must pay both parties, for a total tax rate of 2.9%.

In particular, on March 27, 2020, former President Trump signed a $ 2 trillion emergency stimulus package for the coronavirus, called the Coronavirus Relief, Relief and Economic Security Act (CARES). The law allowed employers to defer Social Security payroll taxes until December 31, 2020; 50% of the deferred amount will expire on December 31, 2021 and the other half before December 31, 2022. The law applies to employees as well.

Certain employers will also be eligible to claim a payroll tax credit for employees who continue to pay but are not working due to the crisis.

FICA tax calculation: an example

An employee earning $ 165,240 a year collects biweekly paychecks of $ 6,885 before taxes and any withholding from the retirement plan. Although Medicare tax is paid on full salary, only the first $ 142,800 is subject to Social Security tax for 2021. Since $ 142,800 divided by $ 6,885 is 20.7, this threshold is reached after the 21st paycheck.

Therefore, for the first 20 pay periods, the total FICA tax withholding equals ($ 6,885 x 6.2%) + ($ 6,885 x 1.45%), or $ 526.70. Only the Medicare HI tax applies to the remaining four pay periods, so the withholding is reduced to $ 6,885 x 1.45%, or $ 99.83. In total, the employee pays $ 8,537.40 to Social Security and $ 2,395.98 to Medicare each year. Although it does not affect the employee’s take-home pay, the employer must contribute the same amount to both programs.

As mentioned above, those who are self-employed are considered both the employer and the employee for tax purposes, which means they are responsible for both contributions. In the example above, a self-employed person with the same salary pays $ 17,074.80 to Social Security and $ 4,791.96 to Medicare.

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