Two Sets of Rules for Social Security Taxes

Social Security taxes are known officially as FICA (short for Federal Insurance Contributions Act) taxes. Employers also have to match those payroll taxes.

FICA taxes consist of two components with different rates. First, the rate is 6.2 percent for the Social Security benefits portion (the Old-Age, Survivors, and Disability Insurance fund), up to a limit of $118,500 for 2016 (same as for 2015). Consequently, withholding from paychecks for Social Security taxes ends at $118,500.

The other FICA rate is 1.45 percent for the Medicare fund (the federal hospital insurance program for the elderly). There’s no ceiling on the amount of wages subject to the 1.45 percent rate, meaning employees with earnings above $118,500 must pay Medicare taxes on every dollar of their salaries, wages, bonuses, commissions, vacation pay, and the like. They surrender $14.50 to Medicare taxes for each $1,000 of compensation ($1,000 multiplied by 1.45 percent).

Medicare surtax on earned income. An additional Medicare tax of 0.9 percent applies to joint filers with wages above $250,000 ($125,000 for married couples filing separate returns) and single filers above $200,000. Their employers pay nothing extra. The levy also applies to individuals with self-employment income above the thresholds.

Self-employment taxes. Similar rules govern for self-employment taxes – Social Security taxes for the self-employed. Individuals liable for self-employment taxes include writers, photographers, artists, and others who operate their businesses or professions as sole proprietorships, in partnerships with others, or as independent contractors.

The self-employment tax rate is 15.3 percent on net earnings (receipts minus expenses). This is twice the 7.65 percent usually paid by employees because self-employed persons pay both the employer and employee halves. Like FICA taxes, self-employment taxes consist of two components with different rates. The rate is 12.4 percent for the Social Security benefits portion, up to a limit of $118,500 for 2016 (again, same as for 2015).

The other self-employment rate is 2.9 percent for the Medicare fund. There’s no ceiling on the amount of net earnings subject to the 2.9 percent rate, meaning self-employed persons with earnings above $118,500 pay Medicare taxes on every dollar of their earnings. They forfeit $29 to Medicare taxes for each $1,000 of earnings ($1,000 multiplied by 2.9 percent).

Deduction for part of self-employment tax. To somewhat ease the hurt, self-employed individuals are able to recoup some of their taxes. They get to deduct one-half of the self-employment tax (line 27 of the 1040 form). This kind of write-off is an “above the line” adjustment, meaning it’s subtracted from gross income to arrive at adjusted gross income, just the same as, say, alimony payments and job-related moving expenses.

Consequently, the write-off is allowable whether individuals itemize deductions for mortgage interest and the like on Schedule A of Form 1040 or use the standard deduction.