Social Security Tax Explained: Taxes 101
The Social Security tax is paid by both employees and employers to help fund the Social Security program. It’s collected in two different forms. The Federal Insurance Contributions Act mandates the payroll tax. The Self Employed Contributions Act mandates the self-employment tax. The tax pays for the disability, survivorship, and retirement benefits of millions of Americans every year.
Benefits of Social Security
The main benefit that everyone thinks of when it comes to Social Security is retirement. However, there are also other benefits. These include survivor’s benefits, dependent benefits, and disability benefits. These other benefits kick in before you would usually reach the traditional retirement age to qualify and are there to help you in times of need. While paying Social Security may not always seem like it’s worth it, remember these benefits.
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How the Social Security Tax Works
The government applies the Social Security tax to earned income by both employees and self-employed taxpayers. Employers will typically withhold this tax from paychecks and then forward it to the government. Note that funds collected from employees for Social Security aren’t put into a trust for that individual employee paying into the fund, but instead are used to pay the existing retirees with a pay-as-you-go system.
The tax is also used to support those who are entitled to survivorship benefits, such as benefits paid to a widower or widow upon the death of a spouse or to a dependent child after parent's death.
Currently, as of 2023, the Social Security tax rate is 12.4%
The employer pays half of this tax and then the employee is paying the other half. The tax will be assessed for every type of income earned by employees, including wages, salaries, and any bonuses received. There is an income limit to which the tax is applied.
Currently, the Social Security tax is taken from any income up to a yearly limit of $160,200. Any income above this amount is not subjected to the tax.
Social Security Tax for Self-Employed Individuals
When you are self-employed then you are considered both the employer and the employee. This means you are responsible for withholding Social Security taxes from your earnings and contribute to the employer’s portion of Social Security. Instead of withholding taxes from your paycheck, you pay all the taxes on earnings when you file your federal income tax return. It’s not possible to withhold from self-employed paychecks since many self-employed people don’t get a regular paycheck. The amount you pay on your federal tax return amounts to both your business contribution and personal contribution.
When self-employed, you will fill out the IRS form Schedule SE: Self-Employment Tax. This is where you report business net profit or loss as calculated on Schedule C. The federal government will use this information to calculate the Social Security benefits you will get later on down the road.
The self-employment tax consists of both the employer and employee portion of Social Security, as well as the employer and employee portion of Medicare, which means the self-employment tax rate is 15.3%.
It may seem like you are getting shorted since you have to pay both the employer and employee portion of the tax but that isn’t necessarily true.
Reduced Tax Liability
When you are self-employed, how much you are paying in Social Security taxes will be passed on your net income. Part of the employer’s matching portion is considered a business expense and then reduces tax liability.
There are also many expenses that reduce your tax liability besides the Social Security tax deductions you are able to take when you are self-employed. Any business expenses that reduce your overall tax will also lower your Social Security taxes. Business deductions are a way you can minimize self-employment taxes, including the Social Security tax.
Keep in mind that when it comes to Social Security benefit calculations, these are based on taxable earnings. If you have more deductions then it lowers your Schedule C income. Lowering this income is a way to reduce how much state, local, and federal income taxes you owe but then this also means it lowers part of your Social Security earnings history and it could mean you get lower benefits in retirement if you didn’t take those deductions.
Should You Maximize Social Security Benefits or Minimize Taxes?
The question then remains if you should skip some or even all of the deductions you are entitled to in order to increase any future Social Security benefits. The answer can be complicated.
Lower-Income Business
These businesses may have more to gain in the future than higher-earning ones because of the way the Social Security retirement benefits are calculated. It also helps to know where your Schedule C earnings are when compared to earnings for past years. If you have had a full 35-year career that is already behind you and you aren’t earning as much in current self-employed business ventures then it may make sense to take as many deductions as you can since your Social Security benefits will be based on the 25 highest-earning years. This way, you are able to lower your Social Security taxes now.
High-Earning Business
However, if you are currently in the higher-earning parts of your career then a higher Schedule C income may help you get larger benefits later. It can be hard to figure this out on your own and a free tax calculator isn’t likely to help since there are so many factors.
However, if you are on the cusp of not even having enough income to give you the credits you need to qualify for Social Security then you may want to forego some deductions now so you can be entitled to some benefits in the future. Working with a tax manager or accountant may be able to help you decide which is best for your future.
Can You Be Exempt from Social Security Tax?
Just like with income tax, it’s pretty hard to avoid these taxes on self-employment income and regular employment income. There will be some exemptions to specific groups of taxpayers. If you do happen to fall under one of these categories then you may be able to save a significant amount of money. Keep in mind that if you were taking advantage of this exemption then you would be ineligible to receive benefits that are given by Social Security.
Qualifying Religious Exemption
There are members of some religious groups that can qualify for an exemption but then it must also be recognized as a religious sect opposed to receiving benefits from Social Security. The religious organization also must have existed at the end of 1950 and must have continuously provided dependent members with a reasonable standard of living since that time. This exemption won’t be automatic and to get it you must apply for it and complete Form 4029. The exemption won’t be available if you have ever been eligible to receive benefits under the program, regardless of whether or not you actually received the benefits.
Nonresident Aliens
Those who don’t have U.S. citizenship or are not legal residents are considered nonresident aliens. Any nonresident alien working in the U.S. will typically pay Social Security tax on the income that is made in the country, even if he or she is working for a foreign company. There are some exceptions. Foreign education professionals and students that are in the country on a temporary basis don’t have to pay taxes. Nonresidents working in the U.S. for a foreign government are also exempt from paying the taxes on their salaries. Families and domestic workers may also qualify for an exemption. There are some other categories of nonresident aliens that are eligible for exemption but in every case, the determining factor is the type of visa that he or she has. You can find the list of visa types that could be exempt from Social Security taxes on the IRS website.
Temporary Student Exception
Students working for the school where they are enrolled in classes may also be exempt from Social Security taxes. However, this only happens if the student gets employment because of their enrollment. If you work full time in the registrar’s office and then also take advantage of the tuition-free enrollment the university gives employees then you are not able to qualify. If you attend school full time and the university gives you a part-time job that is dependent on your enrollment at the school then you would in fact qualify. This exemption is only going to be for wages that you get at the school and not any wages you would earn from other employers.
Foreign Government Employees
Employees of a foreign government will typically be exempt from paying Social Security taxes on income paid due to official responsibilities. The employee will need to be working in a certain capacity on only official business that is related to his or her employment. This exemption doesn’t apply to any servants of employees of a foreign government or their spouse or children unless the same foreign government also employs them.
Income Limitations
If you are ineligible for Social Security tax exemptions then you should know that there are income limits. While this isn’t necessarily an exemption, if you do earn an excess of the maximum for the year then you will be exempt from Social Security tax over that amount.
Other Exemptions
There may also be some other exemptions but these are rare. Certain police officers or firefighters may also not have to pay Social Security taxes if they are part of a qualifying public retirement system. To see if you qualify for some rare exemptions, you want to speak with a tax professional.
What Happens if You Don’t Pay Social Security Taxes?
If you do have an exemption and reason to opt-out of paying the Social Security tax and you do so properly then not paying taxes would result in not getting any benefits. If you don’t have a legitimate reason to opt-out then it’s likely you can’t avoid paying this tax.
If You Are Employed
Employers are going to be required to withhold Social Security tax from your paychecks. You aren’t able to tell your employer how much to withhold from taxes, unlike what you can do with the federal income tax. This means that you will typically end up paying Social Security taxes as an employee whether or not you want to unless you are exempt.
If You Are Self-Employed
As a self-employed individual, it is possible that you may not properly report or pay self-employment taxes, which then includes Social Security tax. If you do this then you could get in financial trouble. If you aren’t reporting all of your income then the IRS can file a return on your behalf of the missing income. The return won’t include any deductions you would be entitled to so it’s possible that you end up owing more than you would have if you just did the right thing and filed on your own.
Since you aren’t paying on time then you are subject to interest and penalties. You get hit with penalties for not filing a return on time, as well as larger penalties for failing to file your return. The IRS can take steps to collect money they think you owe them. They are able to garnish wages, if you do in fact have any W-2 wages, and can seize bank accounts, Social Security benefits, property, and other income. If you don’t report your self-employment earnings then it can also mean you get less Social Security benefits as well.
Why Paying Social Security Taxes Works for Your Benefit
There are benefits to you paying the Social Security tax.
It can be hard to save and invest money. If you are opting out of getting Social Security benefits then that means you need to replace that in the future by saving and investing. Otherwise, you won’t have any income if you aren’t able to work.
While you could have the best of intentions of taking the money you would normally be paying on the Social Security tax and investing it, that may not always happen. It’s possible that you will face a financial emergency, such as your car breaking down, or a medical emergency and you could be spending that money on those expenses. Before you know it, it’s easy to get used to spending that money every month. Then you are putting off investing to cover your retirement until it’s too late.
While it’s true that Social Security benefits won’t allow you to live a lavish lifestyle during your retirement, the benefit can help you survive financially. While it’s inconvenient to pay the tax every year, the inconvenience will provide a safety net once you are at retirement age or if you need those benefits at some other point in your life. Without this safety net, it’s possible you could be completely broke.
Do You Pay Taxes on Social Security Benefits?
The Social Security tax doesn’t have anything to do with the actual Social Security benefits you are receiving. However, retirees that have several different sources of income, such as retirement account withdrawals, part-time work, or pensions, may have to pay taxes on part of the benefits they are getting from Social Security. The federal government will tax up to 85% of Social Security payments for seniors that earn more than a certain threshold but won’t tax the full benefit. If your Social Security income is in fact your only source of income then you likely won’t have to pay taxes on it.
In order to tell if Social Security benefits will be taxable, you have to know where the certain thresholds lie:
Those with a combined income between $25,000 and $34,000 will pay taxes on 50% of their benefits. If the combined income is higher than $34,000 then 85% of the benefits can become taxable. Married couples will face the same tax rate if combined incomes are between $32,000 and $44,000 and there will be taxes up to 85% if the combined income is higher than $44,000.
Those that are receiving Social Security will get a benefit statement at the beginning of each year, which shows the benefits over the past year. This document can be used in order to learn more about the total amount of Social Security payments and you will be able to calculate if your benefits are going to be subject to tax. Individuals are also able to find this form online if they are logged into their Social Security account and go to the Replacement Documents section.
Finally,
Taxes aren’t fun to pay but the Social Security tax can give you some benefits later on. Both employers and employees are paying a portion of the Social Security tax and self-employed individuals will have to pay both portions of that tax.
While there are some exemptions, many individuals are going to be paying this tax without even realizing it since it gets taken right from the paycheck. The Social Security tax doesn’t apply to Social Security benefits but the benefits may be taxed based on certain income limitations.