Since 1937, Social Security has developed into a key element of the retirement plan for most working Americans. Some research indicates that as many as 40 percent of Americans rely on Social Security for their only source of retirement income. Social Security is funded by a tax known as OASDI (Old Age Survivor and Disability Income).
Most people will recognize this as a regular deduction from their paycheck and know it as the Social Security tax. Here's everything you need to know about this tax and the maximum amount that is withheld for it.
Basics of Social Security Tax
Employers are also required to contribute to this tax on behalf of the employee. Both the employee and the employer contribution are based on a percentage of the employee’s gross wages or salary. Since 1990, the rate has been constant. Employers deduct 6.2 percent from the gross wages of the employee and match that tax with a 6.2 percent contribution from the company’s revenue for a total of 12.4 percent contribution to Social Security on behalf of the employee.
Social Security Tax Limit
The contribution percentages are limited to a certain income cap. In 2020, the limit is $137,700. This means that the maximum Social Security tax deducted from an employee’s wages will be $8,537.40 (6.2 percent of $137,700). If the employee earns more than $137,700, no Social Security tax will be deducted from income in excess of the $137,700 cap.
The income cap generally increases each year, as does the Social Security recipient benefit. In 2021, the cap will increase from $137,700 to $142,800.
Exception to the Tax Limit
There is an important exception to the income cap and the resulting Social Security tax an employee sees withheld from his/her paycheck. When an employee changes employers part way through the year, the Social Security tax withholding starts over as if the first dollar earned with the second employer were the first dollar earned in the year.
So if in 2020 a worker earns an annual salary of $137,700 with Employer One and works for this employer through June 30, 2020, and changes jobs and is paid an annual salary of $150,000 with Employer Two, the employee will end up with a combined OASDI deduction of $8,918.7 ($137,700 x 0.062 for half the year + $150,000 x 0.062 for half the year) instead of the cap of $8,537.40.
When Withholdings Exceed the Limit
Of course, this only happens to workers who earn more than the annual cap and who change jobs part way through the year. But if this is you, is there anything you can do to avoid the excess tax and or how do you get it back? Petitioning your second employer to reduce the withholding or to stop it when you reach the maximum for the year won’t help. Regardless of any previous employer withholding, the second employer is required by law to start withholding as if it were the start of the year and deduct until the maximum is reached.
The IRS anticipates this situation, however, and when you file your 2020 tax return, you’ll use Schedule 3 of Form 1040 to claim the excess Social Security tax withheld. This excess amount is treated as a tax credit and either refunded if you’ve overpaid your taxes or used to offset any taxes due if you haven’t had sufficient taxes withheld.
If you earn more than the withholding limit and you change jobs during the tax year, you can anticipate the amount of excess Social Security tax that will be withheld by your second employer and reduce your tax withholdings to compensate. However this can be complicated and unless you earn significantly more than the income cap of $137,700, then it may not be worth determining how to increase your withholdings to compensate for a relatively small overpayment.
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- NIRS Online: Examining the Nest Egg: The Sources of Retirement Income for Older Americans
- IRS: Tax Topics
- IRS: Form 1040, Schedule 3
- Social Security Administration: 2020 Social Security Changes
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Alan Kearl has overseen the commercial, operations and finance areas at the C Level for several leading beauty industry brands. He is a board member, a business consultant and writer. He has an undergraduate degree in Economics from Brigham Young University, and an MBA in Finance from the Krannert School at Purdue University. He's recently been published by Business Insider. You can connect with him on LinkedIn.