How Is Social Security Tax Calculated?

The Old-Age, Survivors and Disability Insurance program (OASDI) tax—more commonly called the Social Security tax—is calculated by taking a set percentage of your income from each paycheck. This percentage is determined by law each year and applies to employees and employers. For 2019, both employees and employers must contribute 6.2% of employee compensation, for a total of 12.4%. Those who are self-employed are liable for the full 12.4%.

The Social Security program provides benefits to retirees and those who are otherwise unable to work due to disease or disability. Social Security often provides the only source of consistent income for people who can no longer work—especially for those with modest earnings histories.

Because Social Security is a government program aimed at providing a safety net for working citizens, it is funded through a simple withholding tax that deducts a set percentage of pretax income from each paycheck. Workers who contribute for a minimum of 10 years are eligible to collect benefits based on their earnings history once they retire or suffer a disability.

Medicare's Hospital Insurance (HI) program is another government program that provides for citizens in need and requires a mandatory withholding tax. Social Security and Medicare taxes are often combined and listed on paychecks as the FICA tax, which stands for the Federal Insurance Contributions Act.

Like the OASDI, the HI tax rate is set each year by law. For 2019, the HI tax rate is 1.45% for employees and employers. Those who are self-employed must pay both portions, for a total tax rate of 2.9%.

Social Security benefits are capped at 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 annual wages or earned income subject to taxation, called a tax cap. For 2019, the maximum amount of income subject to the OASDI tax is $132,900, capping the maximum annual employee contribution at $7,960.80. The amount is set by Congress and can change from year to year. However, no such limit applies to the Medicare HI tax; it is based on an individual’s total annual earnings.

The wage limit is inflation-indexed annually and can be found in IRS Publication 15 for most employees, or Publication 51 for agricultural workers.

According to IRS Publication 15, wages subject to FICA include all income received for services performed, unless specifically excluded. The payment doesn't have to be by cash or check. Wages include salaries, bonuses, commissions, and paid vacation or sick time. Payments in-kind, in the form of goods, lodging, food, clothing, or services are also included unless the employee is a household or agricultural worker. Elective contributions to a qualified retirement plan are subject to FICA. Employer-paid accident or health insurance premiums for an employee, including the employee's spouse and dependents, are not wages and are not included in FICA. Health Savings Account contributions made by the employer are also not considered wages.

For example, Jeff earns $20,000 per year. He elects to contribute $4,000 to his 401(k) plan, and his employer matches 25% or $1,000. His Social Security wages are $20,000: his elective deferral contribution is still subject to FICA, and the additional amount contributed by the employer is not. The Social Security tax withheld from his pay is $1,240.

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

An employee who makes $166,920 a year collects semi-monthly paychecks of $6,420 before taxes and any retirement-plan withholding. Though Medicare tax is due on the entire salary, only the first $128,400 is subject to the Social Security tax. Since $128,400 divided by $6,420 is 20, this threshold is reached after the 20th paycheck.

For the first 20 pay periods, therefore, the total FICA tax withholding is equal to ($6,420 x 6.2%) + ($6,420 x 1.45%), or $491.13. Only the Medicare HI tax is applicable to the remaining four pay periods, so the withholding is reduced to $6,420 x 1.45%, or $93.09. In total, the employee pays $7,960.80 to Social Security and $2,420.34 to Medicare each year. Though 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, meaning they are liable for both contributions. In the example above, a self-employed person with the same salary pays $15,921.60 to Social Security and $4,840.68 to Medicare.

The Social Security tax began in 1937. At that time, the employee rate was 1%. It has steadily risen over the years, reaching 3% in 1960 and 5% in 1978. In 1990, the employee portion increased from 6.06 to 6.2% but has held steady ever since—with the exception of 2011 and 2012. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 reduced the contribution percentage to 4.2% for employees for those years; employers were still required to pay the full amount of their contributions.

The tax cap has existed since the inception of the program 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 in 1955, 1959, and 1965 were designed to address the difference in benefits between low-wage and high-wage earners.

The Social Security tax policy in the 1970s saw a number of proposed amendments and re-evaluations. The Nixon Administration was paramount in arguing that tax cap increases needed to correlate with changes in the national average wage index in order to address benefit levels for individuals in different tax brackets. The 1972 Social Security Amendments Act had to be revamped due to problems with the benefits formula that caused financing concerns. A 1977 amendment resolved the financial shortfall and established a tax cap increase structure 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 financing within the system and to provide reasonable benefit amounts for those who earn higher-than-average wages. Since 1983, the number of American earners who exceeded the tax cap has been approximately 6%.

In the 21st century, a common worry is that Social Security could become insolvent due to longer life expectancies and a shrinking worker-to-retiree ratio. Analysts sometimes suggest raising the Social Security tax as a way to keep the program adequately funded. Most politicians, however, hesitate to endorse this position on account of overwhelming public sentiment against it.

Another common complaint with the Social Security tax is that it is regressive; that is, if a person makes less money, a higher percentage of his income goes to this tax. It is a regressive tax because it only applies to income up to a certain amount. Anyone who earns under $128,400 has an effective Social Security tax rate of 6.2%. Someone who earns $1 million per year, by contrast, pays a much smaller percentage of his total income toward the Social Security tax.