The first step of properly paying your employees is determining how much they earned in a given pay cycle; the second step is calculating how much of that money needs to be withheld for payroll taxes. One tax employers are required to withhold from nearly all of their employees is Social Security tax. This money is deducted from employee paychecks and paid directly to the IRS on the employee's behalf. All employers should have a clear understanding of what the Social Security tax is and how it is paid.
What is Social Security tax?
The Social Security tax, also known as Old-Age, Survivors, and Disability Insurance (OSADI), is a federal payroll tax that applies income earned from paid labor. Nearly all employers, employees and self-employed individuals must pay the Social Security tax.
Social Security tax is typically grouped with the Medicare tax under the Federal Insurance Contributions Act (FICA). Social Security taxes go toward funding the U.S. Social Security Administration's (SSA) Social Security programs, which cover retirement, disability, dependent and survivor benefits.
The Social Security tax is a flat tax, which means all employed individuals (whether they work directly for an employer or are self-employed) pay the same tax rate, no matter how much they earn, until their earnings hit the upper threshold. That threshold is known as the wage base.
The employer is responsible for paying their share of the Social Security tax on the employee's income and withholding the employee's share of the Social Security tax. The employer is responsible for reporting and submitting the collected Social Security tax to the IRS. Self-employed individuals are responsible for reporting and paying the full amount of the Social Security tax themselves. [Want a service to handle all of your payroll deductions for you? Check out our payroll service reviews that we recommend for small businesses.]
Funds paid toward Social Security taxes go into two trust funds:
- The Old-Age and Survivors Insurance Trust Fund (OASI), which pays retirement and survivor benefits for the elderly, their spouses, and surviving spouses or dependents; 10.6% of the Social Security tax goes into this fund
- The Disability Insurance Trust Fund, which goes toward disability benefits for disabled workers; 1.8% of the Social Security tax goes into this fund
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Who pays Social Security tax?
Nearly all employed individuals must pay Social Security tax on their work income. The employee pays one-half of the tax through payroll withholding and the employer pays the other half of the tax.
Under the current rate, employees must pay 6.2% of their total earnings up to the maximum wage base; employers pay 6.2% of each employee's wage earnings up to the maximum wage base. This amount equals the 12.4% that makes up the Social Security tax.
The 12.4% Social Security tax does not include the Medicare tax; this amounts to an additional 2.9%, which is divided between the employee and employer.
While the Social Security tax is paid by almost all U.S. employees, there are some exceptions, which include members of some religious groups, temporary students, temporary student workers, nonresident aliens, foreign government employees, employees of state and local governments that already pay into a government pension plan, and individuals who are self-employed who earn less than $400 annually. Also, those under the age of 18 who work for a family business and those under the age of 21 who are employed as babysitters, housekeepers, or who perform domestic work are exempt from Social Security taxes.
How is Social Security tax calculated for self-employed people?
If an individual runs a small business and does not have any employees (or if they are a freelancer or independent contractor), then he or she is considered to be self-employed. If the self-employed individual earns more than $400 in a year, they are required to pay self-employment taxes. (Self-employed people have the same wage base as all other employees.)
Therefore, they must pay the self-employment tax, which includes both Social Security and Medicare taxes. This works out to 15.3% of the self-employed person's total income (12.4% for Social Security tax and 2.9% for Medicare tax).
How do Social Security tax rates work?
The government adjusts the wage base periodically to keep pace with inflation. The Social Security wage base was increased from $132,900 to $137,700 in 2020 and to $142,800 for 2021. The wage base has grown significantly over the last 10 years. In 2012, the maximum wage base amount for Social Security taxes was just $110,100.
How to calculate Social Security tax
To determine how much Social Security tax is owed for each employee, you multiply the employee's gross income for the current pay period (up to the wage base threshold) by 6.2% to determine your share, and their share, of the Social Security tax.
- If the employee will earn less than $142,800 in 2021, multiply their earnings by 6.2% to determine the amount you (the employer) and the employee must each pay to equal the total of the 12.4% Social Security tax.
- If the employee will earn more than $142,800 in 2021, multiply $142,800 by 6.2% to determine how much you (as the employer) and the employee must each pay. Any amount that the employee earns above this threshold is exempt from Social Security tax.
How to file and pay the Social Security tax
Employers must use IRS Form 941, Employer's Quarterly Federal Tax Return, to report both their share and the employee's share of the Social Security tax (as well as the Medicare tax). This form must be submitted each quarter. Employers must also fill out a W-2 form for their employees, which combines the wage and tax statement for employees on an annual basis. This form shows how much Federal Insurance Contributions Act (FICA) taxes have been withheld.
Even though Form 941 is a quarterly tax form, employers must make monthly or biweekly (i.e., every two weeks) FICA tax payments, which depends on how much FICA tax was paid during the "lookback period." Payroll tax deposits must be made through the Electronic Federal Tax Payment System.
What is Medicare tax?
Medicare tax, which is also known as hospital insurance tax, is a federal employment tax that funds part of the Medicare insurance program. Employers must withhold Medicare tax from each employee's paycheck; self-employed workers are responsible for paying this tax themselves.
Medicare tax pays Part A of the Medicare program. This includes hospital insurance for adults aged 65 years and older and those who have specific disabilities or medical conditions. The insurance covers hospital visits, hospice care, nursing home care and some home healthcare.
Where does the Medicare tax go?
Just like the collected Social Security taxes, Medicare taxes are deposited into trust funds, which are managed by the U.S. Treasury. The funds collected from Medicare taxes go into the Hospital Insurance Trust Fund, which is used to pay Medicare Part A. The funds for Medicare Part B (for medical insurance) and Medicare Part D (for prescription drug coverage) come from the Supplemental Medical Insurance Trust Fund. These funds come from premiums paid through tax revenue, investment earnings and beneficiaries.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded the Medicare program in 2020. Its purpose was to cover treatment for people who became ill due to COVID-19. The fund covers hospital stays and durable medical equipment that relates to COVID-19. Under the CARES Act, employers can defer their portion of the 6.2% Social Security tax.
2021 Medicare tax rates
In 2021, the Medicare tax rate is 2.9%. Employers and employees split the cost of this tax evenly (i.e., employers pay 1.45%, and W-2 employees pay 1.45%). Self-employed workers pay the full 2.9%, as they are both the employer and employee. There is no income limit on the Medicare tax.
Additional Medicare Tax
There is an additional Medicare tax on employees whose total earned income (which includes wages, compensation and self-employment income) exceeds a certain amount. The threshold is:
- $200,000 for single filers
- $250,000 for married couples who file jointly
- $125,000 for each married person who files separately
The additional Medicare tax rate is 0.9%, which applies to the amount of income that exceeds the threshold. For example, if a single employee earns $225,000, they must pay their share of the Medicare tax (1.45%) on the first $200,000 and 0.9% on the remaining $25,000. The employer must withhold and submit all of the employee's Medicare taxes.
However, they are only responsible for paying 1.45% on the first $200,000; the employee is solely responsible for any amount over $200,000.