Maximum Social Security Tax: Everything You Need to Know
The federal government mandates that a maximum social security tax be imposed on employees (including those who are self-employed) and employers. 8 min read
Maximum Social Security Tax
The federal government mandates that a maximum social security tax be imposed on employees (including those who are self-employed) and employers. The tax proceeds going into a fund that is used to compensate those individuals that have earned Social Security payments. For example, those individuals that have reached a certain age and disabled individuals are two examples of individuals who benefit from the Social Security program. If you are an employee of a corporation, you will notice that Social Security tax is one of those taxes that are taken out of your paycheck.
What is the Maximum Social Security Tax in 2017?
As previously stated, the Social Security program is vital to all of its recipients, which include senior citizens and disabled person. Their critical benefits are paid largely from the Social Security program that is funded from your periodic payroll deductions. The amount of Social Security tax that is deducted from each of your paychecks is dependent upon the amount of your income. If you are a highly compensated individual, it is very likely that you will have to pay a maximum Social Security tax in 2017 of $7,886.40. If you are self-employed, you will pay twice that amount. For comparison purposes, in 2016, the maximum Social Security tax an individual would be expected to pay was $7,347 or twice that amount if they were self-employed. The difference between these numbers is $539.40 for employees and double that amount or more than $1,000 for those who are self-employed.
Understanding How Social Security Taxes Work
Any individual working in the U.S. will be required to pay a share of his/her wages toward the Social Security program. Depending on the amount of income you earn on an annual basis, you may be required to pay Social Security taxes on the entire amount of your income. Each year, a cap on the amount of earned income subjected to Social Security taxation is established. Any earned income up to the amount of that cap will be subjected to a 6.2 percent Social Security tax. The employee must pay 6.2 percent tax and the employer must pay 6.2 percent tax. A self-employed individual will pay 12.4 percent tax.
If an individual has earned income in a given year from both work as an employee as well as from self-employed work, the income earned as an employee will be the first portion to be considered for social security taxation. It should be noted, however, that if the employee’s earned income as an employee does not exceed the published annual cap, the individual must pay additional Social Security tax on the self-employed wages up to the amount of the cap.
Those individuals who are self-employed are ultimately subject to taxation as both the employer and the employee to the tune of 12.4 percent or $15,772.80 in 2017. Though the federal tax regulations will require self-employed individuals to pay the Social Security tax upfront, a self-employed individual may deduct half of the amount upon filing your federal income tax form.
To put the increase in 2017 Social Security cap in perspective, there are roughly 170 million individuals who will pay Social Security tax this year. Of those 170 million, 12 million or 7 percent will be required to pay more next year as a result of the maximum taxable amount.
Reason behind the Increase of Social Security Tax from 2016
In 2016, the U.S. Congress set the cap on taxable Social Security wages at $118,500. In 2017, the cap on Social Security wages was raised more than 7 percent to $127,200. It should be noted that in 2015, the cap remained was the same as 2016 - $118,500. This is provided to put some context around the greater than 7 percent annual increase. Regardless, this 7 percent increase may seem excessive if you compare the figure to the .3 percent Cost of Living Adjustment provided by Congress to current Social Security recipients. If you look back at the history books, you will notice that the largest ever annual increase in the maximum cap on wages for the Social Security program occurred in the year 2017.
Wage growth in the U.S. has been on a meteoric rise as the growth rate over the past two years equals the 7 percent increase in Social Security cap for 2017. This makes sense as the cap on taxable Social Security wages is tied directly to the amount of wage growth. It is interesting to note that federal law dictates that in years in which recipients have not received a Cost of Living Adjustments (COLA), there can be no increase in the Social Security tax program. Therefore, since Social Security program beneficiaries were not awarded a COLA during calendar year 2016, the cap on taxable Social Security wages remained flat at $118,500.
Future Increase in Social Security Tax
As a follow-on to the previous section discussion, the amount of taxes collected from individuals in the form of wages will usually increase on an annual basis. Additionally, the Social Security programs may run into some highly publicized funding issues in the future, which will likely require Congress to take actions to keep the Social Security program adequately funded for its beneficiaries. The 2016 Annual Social Security report indicated that the cost to run the program will likely exceed the amount of taxes being paid into the system as early as 2020.
As the program stands currently, an estimated $11 trillion shortfall is headed our way. If a solution cannot be devised and agreed upon, the legislature will be forced to require the program to begin cutting benefit payments by as early as the year 2034. If this were to occur Social Security beneficiaries stand to lose out on more than 20 percent of benefits they have earned from the program. This could be a tremendous blow to those individuals who lack additional streams of income and rely solely on Social Security.
One of the reasons for the impending shortfall in 2034 is the recent shift in demographics as it relates to the number of workers contributing to the program. Over the last 30 years, there have been roughly 3.3 workers contributing tax dollars to the Social Security program for every beneficiary. This ratio is expected to fall to approximately 2.2 workers per beneficiary by 2035.
All of our most recent Presidents have essentially promised not to cut Social Security benefits, including our current President, Donald Trump. This position is largely consistent with the feelings of most Americans across political parties and socioeconomic status level. While President Trump has tried to assure his supporters and the American people that he intends on keeping his campaign promise to not raise the Social Security tax, given the state of the program, a tax increase seems to be a real likely possibility in the immediate future.
One of the other reasons usually cited for the impending shortfall in 2034 is the rise in income inequality across the U.S. population. More specifically, in the U.S. the percentage of the working population making over the 2017 cap of $127,200 is roughly 6 percent. This has not changed significantly over the years. However, the percentage of income subject to Social Security taxation has fallen from 90 percent in the early 1980’s to 83 percent in 2014.
As a result of the reasons set forth for the impending shortfall, experts often point to two ways in which we can close the gap. We could increase the actual Social Security tax rate on employees and employers or we could raise or eliminate the cap on Social Security taxable wages.
Social Security Tax System Flaws
Many proponents of raising or eliminating the cap on Social Security wages will point to the fact that an individual who earns $127,200 per year will be the same amount of Social Security tax as a person who makes $10 million per year. Since the realization of the expected shortfall, Congress has been debating the need to raise the Social Security taxable cap to make the Social Security taxation mechanism more equitable, while also serving a dual purpose of generating additional revenue to aid in closing the gap in funding the Social Security program. Opponents of raising the cap Social Security wages have pointed out the impact on the self-employed workers. As we have learned, self-employed workers must cover both the employer and employee tax contributions to the tune of 12.4 percent. Increasing the cap will cause these individuals to pay much more in tax and could be a deterrent to growing the economy by discouraging individuals from starting small businesses.
FICA Rates Set by Law
Often we speak about Social Security tax or OASDI (old age, survivor and disability insurance) tax as synonyms to those other taxes, FICA taxes, which include Medicare and Social Security and can be found on your paystub. The Federal Insurance Contributions Act was enacted to address payroll taxation around Social Security and Medicare. The tax rates for Social Security and Medicare are set by the legislature and would thus require Congress to propose and pass an amendment to change the rates. Social Security rates should not be confused with federal income tax marginal rates, which apply to all earned income and is progressive in nature by applying higher rates of taxation to those who earn more.
The current Medicare payroll tax rate for employees and employers is 1.45 percent on all earned income. Self-employed workers will pay 2.9 percent Medicare rates. No cap has been instituted on Medicare taxation.
Additional Medicare Tax
With the passing of the Affordable Care Act, Congress instituted an additional employee-paid Medicare tax that subjects income over a certain threshold to an additional 0.9 percent Medicare tax. The current threshold for annual earnings that would subject to the Additional Medicare Tax are as follows:
- $250,000 married – joint filers
- $125,000 married – separate filers
- $200,000 for single and all other tax filers
This additional Medicare tax applies to all wages, compensation and self-employment income that exceeds the established threshold in that calendar year. The wages, compensation and self-employment income thresholds are not inflation-adjusted, and thus they apply to more employees each year.
Marginal Rise of Benefit Payments
In 2017, the monthly Social Security program benefit payment will increase roughly 0.3 percent. The increase of 0.3 percent is a COLA that is indexed to the Consumer Price Index that reflects the rising cost of consumer staples. The Consumer Price Index is determined by the Department of Labor and is a vital component in calculating the COLA for the Social Security program.
Under the current Social Security program structure, the maximum Social Security benefit payout for those workers who have retired at their full retirement age is roughly $2,687 per month. This is a $48 per month increase of the amount from 2016. It is estimated that average monthly Social Security payout for all retired workers will be roughly $1360, which reflects a $5 increase from 2016. While the increase compared to 2016 is relatively low, there was no COLA in 2016 as inflation remained very low, so the CPI had not increased to warrant a COLA.
Increases in Retirement Earnings
Individuals who were born between the years of 1943 and 1954 are slated to reach full retirement age at 66 years of age. Social Security benefit payments will be limited by law if an individual continues to earn income. For 2017, the amount an individual can earn before their benefits are impacted is $16,920. A different earnings test will apply in the year an individual reaches his/her full retirement age.
2017 Income Tax Brackets
In 2017, income tax bracket adjustments were issued in October 2016. The level of an individual’s income that becomes subject to higher progressive tax brackets generally will influence many decisions by an employee. Such decisions include how much to defer in a 401(k) plan, which serves to greatly reduce an employee’s taxable earnings in a given year.
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