What Is the Social Security Tax?

Definition and Examples of the Social Security Tax

Women sitting at a kitchen table with elderly man, pointing at paperwork
•••

RichLegg / Getty Images

The Social Security tax was created in 1935 as part of the Old Age, Survivors, and Disability Insurance (OASDI) Act, which was set up by Congress as part of the original Social Security Act. It provides benefits to the elderly, survivors of those who are eligible to receive benefits, and to disabled individuals, provided that they pay in during their working lives.

The OASDI program grants Social Security credits to workers and self-employed small businessowners for their wages, salaries, and other earnings over their work lifetime, up to a maximum amount of earnings each year.

What Is the Social Security Tax?

The OASDI program is funded by contributions from employees and employers through Federal Insurance Contributions Act (FICA) taxes. FICA taxes are comprised of both Medicare and Social Security. These taxes are based on a percentage of the employee's gross pay, and both employee and employer ​contribute to this percentage in equal amounts.

The Social Security tax rate is 6.2% of earnings for employees and 6.2% for employers' contributions, for a total of 12.4% as of 2020.

Small businessowners and independent contractors must also pay FICA taxes in the way of the self-employment tax, which is based on the net incomes of their businesses. Self-employed individuals must pay the full 12.4% toward Social Security, plus Medicare for a total self-employment tax of 15.3%.

How Does the Social Security Tax Work?

The Social Security tax that workers, employers, and the self-employed pay goes into a trust fund. It works out to 85 cents for each dollar in tax paid in as of 2020. The money pooled into this fund by all taxpayers is then used to pay Social Security retirement benefits in the current year to individuals who have qualified.

The other 15 cents go into a fund for the benefit of the disabled.

Your Social Security tax dollars effectively pay for benefits for those who are presently collecting. Your own benefits will be funded by the tax paid by subsequent generations when you retire.

Requirements for the Social Security Tax

Employers have several responsibilities relating to FICA taxes: 

  • Employers must withhold FICA taxes from the paychecks of all employees until the employee has reached the Social Security maximum or wage base for the year, which is $137,700 as of 2020. Earnings over this amount aren't subject to the Social Security tax for the remainder of the year. The wage base increases annually to keep pace with inflation.
  • Employers also must set aside as "payroll taxes payable" an equal amount for each employee for each pay period, as the employer portion of FICA taxes.
  • Employers must report the amounts withheld from employee paychecks each quarter on IRS Form 941.
  • Employers must make periodic payments to the IRS for the employee and employer contributions to FICA taxes. 
  • They must report to employees each year on their total income and Social Security income for the previous tax year on Form W-2.

Requirements for the Self-Employed

You must calculate the amount of self-employment tax you owe each year when you complete your small business tax return using IRS Schedule C if you're self-employed. This self-employment tax calculation is made on Schedule SE. The OASDI and Medicare taxes are added together to make up self-employment tax. 

You must pay these taxes in addition to your federal income tax for the year. Both are based on the net income from your business after you've deducted your business expenses on Schedule C.

The self-employment tax isn't deducted from the amounts you take from your business as an owner, so you must pay quarterly estimated taxes during the year.

Check with your tax professional for more information on self-employment taxes and estimated taxes. 

Corporate owners don't have to pay Social Security and Medicare taxes on dividends received, but they do have to pay these taxes if they work as employees in their businesses. 

Key Takeaways

  • The Social Security tax has been imposed since 1935 when it was first created under the terms of the Old Age, Survivors, and Disability Insurance (OASDI) Act.
  • The Social Security tax is a flat rate of 12.4% of an individual’s earnings, half of which is paid by the employee and half of which is contributed by employers.
  • Businessowners and independent contractors must pay the full 12.4% as the self-employment tax.
  • The tax is deposited into a trust fund to provide benefits for the elderly and disabled individuals.

Article Sources

  1. IRS. "Topic No. 751 Social Security and Medicare Withholding Rates." Accessed Sept. 2, 2020.

  2. IRS. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Sept. 2, 2020.

  3. Social Security Administration. "Understanding the Benefits." Page 3. Accessed Sept. 2, 2020.

  4. Social Security Administration. "Contribution and Benefit Base." Accessed Sept. 2, 2020.