This article was originally published on Dec. 12, 2015, and updated on Jan. 8, 2017.
Taking advantage of some simple tips can help you cut your tax bill.
Taxpayers hate income taxes above all else, and the irritation of preparing a return before the filing deadline is almost as bad as actually paying the tax. Yet the Social Security payroll tax actually hits many taxpayers harder than the income tax. This tax largely flies under the radar because it's withheld directly from paychecks without any need for a year-end tax return.
During most years, the maximum Social Security tax rises slightly, but for 2016, taxpayers got a rare break, as the amount remained the same, at $7,347 for employees and $14,694 for self-employed individuals. Let's look at how the Social Security tax works and why the maximum stayed the same for 2016.
Social Security taxes and the wage base
The government imposes Social Security payroll taxes on only a certain amount of earnings each year. Known as the Social Security wage base, that maximum amount for 2015 was $118,500, and most years, the wage base rises. As you can see below, the amount of earnings subject to Social Security payroll taxation has increased dramatically since the beginning of the Social Security program.
The reason why the wage base remained at $118,500 for 2016 is that inflation remained in check throughout the measuring period in 2015. As a result, Social Security didn't have a cost-of-living adjustment, and the laws governing Social Security mandate that no increase in the wage base is to occur when there's no COLA in a given year.
In addition, although the actual tax rate has generally risen over time, the same 6.2% rate on earnings that has generally prevailed for more than a quarter-century remains in force. With the exception of a two-year period from 2011 to 2012, when the payroll tax rate was temporarily reduced by 2 percentage points to 4.2%, the tax rates on earnings for Social Security tax purposes have risen steadily over time.
When you do the math, $118,500 multiplied by 6.2% gives you $7,347, and that therefore represents the maximum amount that workers are slated to pay in 2016.
Self-employment and the double hit
What many people don't realize about Social Security payroll taxes is that their employer also pays into the system on their behalf. Employers pay a matching 6.2% Social Security tax on behalf of their employees, bringing the total tax paid to 12.4%. The same wage base limit applies to the employer portion of the tax.
For self-employed individuals, what this means is that they end up having to pay both the employee and employer share of the tax. That essentially doubles their potential tax liability, making the maximum amount $118,500 multiplied by 12.4% or $14,694. Since the self-employed are responsible for paying themselves, they must incorporate this amount into their quarterly estimated tax payments or else risk penalties for underpayment.
Why is my FICA tax higher?
If you look at your paycheck, you might see that the total amount withheld under what's called FICA is higher than the 6.2% rate above. That's because FICA also includes Medicare tax withholding, which has a rate of 1.45% and has no maximum wage base limit.
Because payroll taxes are assessed at a flat tax rate, low-income taxpayers often find that they're higher than the income tax liability. As earnings increase, however, income taxes tend to rise at a faster pace, since the marginal rates of 10% up to 39.6% are all far greater than the 6.2% Social Security tax rate. The fact that there are no standard deductions or personal exemptions available for Social Security tax is a big part of this disparity.
The maximum Social Security tax for 2016 is the same as it was in 2015, but taxpayers shouldn't expect that to happen very often in the future. Over the long run, you can expect Social Security taxes to rise slowly but surely from year to year.