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Social Security Taxation: Understanding How It Works

| August 09, 2023

As the anniversary of the Social Security bill being signed into law (August 14, 1935)[i] approaches, we’re reminded of the intricate workings of the U.S. tax system. Social Security, a vital program designed to provide financial support to retired and disabled individuals, is funded through payroll taxes.[ii] Let’s explore the fundamentals of Social Security taxation, shedding light on how it works and its implications for both employees and employers.

  • The Federal Insurance Contributions Act (FICA): Social Security taxation is governed by the Federal Insurance Contributions Act (FICA). Under FICA, employees and employers must contribute a portion of their income to fund Social Security and Medicare programs. These contributions are collectively known as payroll taxes.[iii]

 

  • Social Security Tax: The Social Security tax, a component of FICA, is specifically earmarked to fund retirement, disability, and survivorship benefits. From 2020 - 2023, the Social Security tax rate stands at 6.2% for both employees and employers.[iv] This means that employees contribute 6.2% of their income, while employers match that amount.

 

  • Earnings Subject to Social Security Tax: There is a cap on the earnings subject to Social Security taxation. In 2023, the maximum taxable earnings limit is set at $160,200.[v] This means that any income earned above this threshold isn't subject to Social Security tax. However, being aware of this limit is essential as it can affect your tax liability and retirement benefits.

 

  • Self-Employment Tax: The Social Security and Medicare taxes are combined into a single self-employment tax for self-employed individuals. The self-employment tax rate for Social Security is 12.4% (double the rate for employees), and the Medicare tax rate remains 2.9%.[vi] However, self-employed individuals can deduct the employer portion of these taxes when calculating their adjusted gross income.[vii] Self-employed individuals have additional responsibilities when it comes to Social Security taxation. They must calculate and pay the employer and employee portions of the self-employment tax, making proper estimation and planning crucial.

Disclaimer: The above are not inclusive of all Social Security tax considerations but merely a glimpse into some.

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[i]https://www.ssa.gov/history/50ed.html#:~:text=Roosevelt%20signed%20the%20Social%20Security,work%20begun%20by%20the%20Committee

[ii]https://www.ssa.gov/news/press/factsheets/HowAreSocialSecurity.htm#:~:text=Social%20Security%20is%20financed%20through,self%2Demployed%20pay%2012.4%20percent.

[iii] https://www.ssa.gov/thirdparty/materials/pdfs/educators/What-is-FICA-Infographic-EN-05-10297.pdf 

[iv]https://www.ssa.gov/oact/cola/cbb.html

[v]https://www.pgpf.org/blog/2023/02/should-we-eliminate-the-social-security-tax-cap-here-are-the-pros-and-cons#:~:text=The%20limit%20on%20annual%20earnings,of%20%2413%2C200%20from%20last%20year.

[vi]https://bench.co/blog/tax-tips/self-employment-tax/#v5mi-a

[vii]https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes#:~:text=Employers%20calculate%20Social%20Security%20and,figuring%20your%20adjusted%20gross%20income

This document is for educational purposes only and should not be construed as legal or tax advice. One should consult a legal or tax professional regarding their own personal situation. Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products offered by an insurance company. They do not refer in any way to securities or investment advisory products. Insurance policy applications are vetted through an underwriting process set forth by the issuing insurance company. Some applications may not be accepted based upon adverse underwriting results. Death benefit payouts are based upon the claims paying ability ofthe issuing insurance company. The firm providing this document is not affiliated with the Social Security Administration or any other government entity.