In addition to paying income tax, an employee must contribute to Social Security and Medicare taxes, which are critical to funding these federal benefits programs. The employee shares this obligation with the employer. The employer withholds Social Security and Medicare taxes from the employee’s paycheck and sends them directly to the IRS. An employee must pay 6.2 percent of their wages (up to a wage ceiling) in Social Security taxes, and their employer will match that amount. As of 2019, the wage ceiling is $132,900. Any wages received beyond that amount are not subject to Social Security taxes.
Medicare taxes consist of two parts. The first part is similar to Social Security taxes in that the employer and the employee each pay half of the tax, and it is subject to an annual wage ceiling. As of 2019, the annual wage ceiling is $200,000 for taxpayers who are filing individually and $250,000 for spouses filing jointly. This component of Medicare taxes is set at a total of 2.9 percent of the employee’s wages up to the wage ceiling, which means that the employee pays 1.45 percent.
The second part of Medicare taxes applies to any wages received beyond the annual wage ceiling. This tax is fully paid by the employee and does not involve any contribution by the employer. It is important for employees to understand that the annual wage ceiling functions differently for Medicare taxes than for Social Security taxes. The ceiling limits the employer’s tax obligation but not the employee’s tax obligation. Thus, an employee will need to pay both the 1.45 percent tax and the 0.9 percent tax (a total of 2.35 percent) for any wages that exceed the ceiling.
People who are self-employed must account for the employer contributions to their Social Security and Medicare taxes, as well as the employee contributions. This means that they must pay twice the amount of Social Security taxes, which will comprise 12.4 percent of their earnings up to the wage ceiling. They also must pay the full 2.9 percent in Medicare taxes for earnings up to the wage ceiling. Finally, they still must pay the 0.9 percent Medicare tax on earnings that exceed the wage ceiling. As a result, self-employed individuals face a Social Security and Medicare tax burden covering 15.3 percent of their earnings, and potentially more in some cases.
On the other end of the system, people who receive Social Security benefits often wonder whether they can be taxed on their benefits as earnings. The general rule is that you do not need to pay tax on Social Security benefits, but exceptions apply to taxpayers who earn a combined income above a certain threshold. Combined income is calculated by adding half of your total Social Security benefits during that year to any other income that you receive, including tax-exempt interest. If a taxpayer filing individually receives more than $25,000 in combined income, they will need to pay taxes on some of their Social Security benefits. Spouses who are filing jointly will need to pay taxes on some of their benefits if they receive more than $32,000 in combined income. Spouses who are filing separately will need to pay taxes on some of their benefits regardless of their combined income level, unless they did not live together at some point during the tax year. This allows each spouse to apply the $25,000 threshold, which can result in tax savings.
An individual taxpayer who receives a combined income between $25,000 and $34,000 will need to pay taxes on up to half of their benefits. An individual taxpayer with a combined income greater than $34,000 will need to pay taxes on up to 85 percent of their benefits. By contrast, spouses filing jointly with a combined income between $32,000 and $44,000 will need to pay taxes on up to half of their benefits. Spouses filing jointly with a combined income greater than $44,000 will need to pay taxes on up to 85 percent of their benefits.
As long as they continue working, it may make sense for an aging taxpayer to refrain from claiming their Social Security benefits until after they reach their full retirement age. Their benefits will increase on an annual basis until they turn 70, after which there is no further advantage to waiting to claim them.
