Social security tax and social security benefits are part of the system where working individuals pay into the social security system in order to receive payments during retirement or other periods when they cannot work. Most working people split the costs of social security with their employers. The self-employed also pay social security tax. Many people recognize this tax as the “FICA” line on their pay stub. This stands for the “Federal Insurance Contributions Act” and the Social Security and Medicare taxes levied under it are used to fund the Social Security system.
Social security tax amounts depend on your wages. If you work for an employer, 4.2% of your wages in 2012 is withheld from your paycheck. Your employer deposits the withheld amount, along with a 6.2% contribution to the Social Security program. In 2012, the employee tax and contribution to Social Security stops after the first $110,100 ($106,800 in 2011) of wages. (The Social Security contribution rates, or tax rates, were reduced in 2011 for the employee but extended until February 29, 2012. If the 2% employee payroll holiday is not extended, the employee rate reverts to 6.2% on income paid after February 29th.) The reduced tax rate for earnings in 2012 is applicable to the first $18,350 of your total wages. Additionally, if you work for an employer, 1.45% of your wages was withheld and the employer made a matching 1.45% contribution to the Medicare program, making the total withholdings 7.65%. There is no income ceiling for Medicare taxes.
Social security tax for self-employed workers are different. You paid 10.4% of your taxable income into the social security and Medicare programs, up to the first $110,100 of income. You continued to pay 2.9% on the rest of your earnings above $110,100. Although the impact on you is greater because you pay twice the rate of employees, you get a break at tax time. You can deduct half of your federal self-employment taxes from your income when it comes time to pay your federal income tax. (For self-employed workers, the Social Security tax rate has dropped from 12.4 percent to 10.4 percent this year, due to provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.)
While both Social Security and Medicare programs are payroll taxes, they function differently. For example, there is no maximum income base for Medicare taxes. Every dollar is taxed, whereas Social Security has a maximum wage base of $110,100. If you have gross wages from a job and net income from self-employment that equal $110,100, this is the maximum income base to which Social Security tax would apply. Medicare taxes would be assessed not only on the $110,100, but also on any amount over $110,100.
Social security taxes are collected and placed into two trust funds at the United States Treasury. One is the Old Age and Survivors Insurance (“OASI”) and the other is the Disability Insurance (“DI”) trust fund. The OASI pays for retirement and survivors' benefits. The DI pays disability benefits. There are also two Medicare trust funds including Hospital Insurance (“HI”) and Supplementary Medical Insurance (“SMI”). Most of your Social Security taxes (5.35 of the total 7.65 percent) go to OASI.
The trust funds were set up with the goal of funding current users and setting aside funds to prepare for the future. Any money not used to pay benefits is invested in special U.S. government bonds to build future funds. The goal is for the funds to take in more money than they pay out in order to prepare for the increasing number of retirees. The status of the funds and their future ability to pay Social Security and Medicare benefits has been a source of controversy and potential examination by Congress.