Social Security—The Employment Tax
The Social Security Act, also called Federal Insurance Contributions Act (FICA), was signed into law by President Franklin D. Roosevelt on August 14, 1935. In addition to several provisions for general welfare, the new Act created a social insurance program designed to provide retired workers age 65 or older a continuing income after retirement.
The significance of the new social insurance program was that it sought to address the long-range problem of economic security for the aged through a contributory system in which the workers themselves contributed to their own future retirement benefit by making regular payments into a fund.
The first task was the need to register employers and workers by January 1, 1937. The Social Security Board contracted with the Post Office to distribute and collect applications and forward them to Baltimore where Social Security Numbers (SSN) were registered and various employment records established. More than 30 million SSN cards were issued and numbers assigned through this early procedure. With payroll commencing after January 1, 1937, employees and employers started paying into the “Trust Fund.” According to the Social Security Administration, more than $4.5 trillion has been paid into the Trust Fund and more than $4.1 trillion has been paid out in benefits.
From 1937 – 1949, employees and employers each paid in 1% of the first $3,000 of wages. From 1949 through 1974, the annual maximum taxable wage climbed from $3,000 to $13,200. The contribution percentage climbed from 1% to 4.95% for both employer and employee. To put it in perspective, from 1937 to 1949, the employee and employer each paid in $30 for the year (assuming the employee earned $3,000). By 1974, each paid in $653.40 if the employee earned the maximum $13,200. In 1975, due to legislative changes, the maximum earnings subject to social security started climbing at a very fast clip.
In 1975 – $14,100; in 1980 – $25,900; in 1985 – $39,600; in 1990 – $51,300; in 1995 – $61,200; in 2000 – $76,200; in 2007 – $97,500; and in 2008 – the first $102,000 is subject to tax.
For 2009 and 2010, if you earned $106,800 or more, you and your employer paid $6,621.60 into the fund—or $13,243.20. In 2011 and 2012, employees got a 2% reduction. This means they paid $4,485.60 and their employer paid $6,621.60 for a total of $11,107.20 for the year.
Beginning January 1, 2013, the 2% reduction has expired. If you earn more than $113,700 in 2013, you will pay $7,049.40 and your employer will match this amount.
A Medicare tax was imposed starting in 1966 at a rate of 0.35% from both employee and employer. Until 1990, the Medicare tax was imposed on the same wage base as social security. From 1991 – 1993, there was a different and much higher wage base on which Medicare tax was imposed. In 1993, the wage base for Medicare was repealed and is now paid on all earned income at a rate of 1.45% each. To put this into perspective, if you earn $113,700 in 2013, both you and your employer will pay $1,648.65 ($3,297.30 total), in addition to the social security tax, to the Medicare “pot.”
Self-Employed Persons
Starting in 1951, self-employed individuals started paying these taxes. Keep in mind that as a self-employed person you are both the employee and the employer. Initially the tax paid by the self-employed was only 50% higher than that amount paid by an employee (when 2% was withheld from an employee, the self-employed person paid in 3%). Starting in 1984, the same total tax was imposed on the self-employed as the total paid by employee and employer—12.4% today (6.2% for employee and employer) and 2.9% for Medicare (1.45% each side). As a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the self-employed rate was reduced 2% to 10.4% for 2011 and 2012. The same tax act also reduced the 6.2% employee rate to 4.2% for 2011. The rates remained during 2012 and then returned to 12.4% for Social Security and 2.9% for Medicare in January 2013.
This is the main reason we tell people going out on their own to be very careful when determining their hourly billing rates. As a self-employed person, you will pay 15.3% in FICA on your first $110,100 of income and at least 10% federal and 6% state tax. You are immediately at the 31.3% tax bracket, but more likely at 48.3% (15.3% FICA, 25% federal and 6% state). This is 50% in taxes before you have the take home pay.
How is the Tax Paid
Employers are required to withhold the social security tax and Medicare from employee’s wages. They are then matched by the employer, then paid to the federal government along with any federal withholding you have requested on your Form W-4.
Certain employers must now make their deposits through electronic deposit. The employer will be notified by the first of the year if they must deposit electronically. Once you meet these requirements, you will always pay electronically. Eventually, all employers will be required to make the payments electronically rather than by check at the bank.
Self-employed persons calculate their self-employment tax based on their net earned income and report it on Form 1040. You are required to remit the self-employment tax with your federal income tax generally through quarterly estimated taxes.
Employer Returns
The employer is required to file Form 941, Employer’s Quarterly Federal Tax Return, each quarter. This return details the wages subject to tax for the quarter, as well as the amount of social security tax, Medicare tax and federal withholding collected each pay period. These returns are matched with your deposits of the tax. Failure to make timely deposits of the taxes withheld is penalized severely. These funds are not the employer’s funds—they are either the employee’s requested withholding or “trust fund” taxes.
At the end of the year, the employer files W-2s with the federal government and the Social Security Administration. This recaps by person the taxes reported on the quarterly 941 forms. If you would like further information regarding this topic or any other tax related issue, contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
