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Here's How Higher Earners Get a Major Break on Social Security Taxes

By Maurie Backman - Dec 1, 2020 at 7:36AM

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Social Security taxes seem to favor the wealthy, but that's not the whole story.

Though Social Security serves as a critical income source for millions of retired seniors, you'll often hear that some aspects of the program are downright unfair. One such example is the way workers pay into the program. Critics of the current system have long argued that the rich don't pay their fair share of Social Security taxes. Are they right?

Why higher earners seem to come out ahead

Social Security gets the bulk of its revenue from payroll taxes, but those taxes don't apply to all wages. There's an earnings cap established each year that determines what level of wages workers pay taxes on.

In 2020, that limit is $137,700. In 2021, it will increase modestly to $142,800. But beyond that point, higher earners are off the hook on paying taxes into Social Security.

Social Security card on W-2.

Image source: Getty Images.

Here's why that's unfair: Someone earning $142,800 in 2021 will pay the same amount of Social Security tax as someone earning $400,000. Put another way, someone earning $40,000 will pay Social Security taxes on all of his or her wages, while something earning $400,000 will pay those taxes on less than half of his or her wages.

Clearly, that's problematic, right? Well, not necessarily.

While it's true that higher earners don't pay taxes on all of their wages, they also don't get all of their wages counted toward their future benefits. Someone earning $300,000 next year will only have $142,800 factored into his or her personal benefits calculation.

Social Security benefits are based on personal earnings histories. Specifically, benefits are calculated by taking workers' average monthly wages, adjusted for inflation, over their 35 highest-paid years in the labor force. But those wages always max out at the annual cap so that higher earners don't get more "credit" toward a higher benefit down the line.

Still, there are those who feel that higher earners should pay more into Social Security. President-elect Joe Biden is one of them. His plan is to enact Social Security taxes on earnings that exceed $400,000. In other words, the annual wage cap would still apply, and workers wouldn't be taxed on earnings that fall between the annual limit and $400,000, but beyond that point, those taxes would come back into play.

Will higher earners who pay more tax into Social Security have those extra wages counted toward their future benefits? Probably not. Otherwise, all of that extra revenue for Social Security could effectively be a wash. But is that the fairest system? Well, that's up for debate -- and it seems likely that lawmakers will, indeed, discuss that notion in detail once Biden enters the Oval Office and starts putting his Social Security plans into motion.

Biden will need the support of Congress to implement a change like the one he's suggesting. Many lawmakers will no doubt oppose the idea. It's easy to make the case that Social Security -- a program that's desperate for revenue -- should not be letting higher earners off the hook by following an annual wage cap for tax purposes. But it's also easy to counter that higher earners shouldn't simply pay more for nothing in return. It'll be an interesting conundrum for lawmakers to try and solve.

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