Employers, employees, and self-employed individuals all pay the Social Security tax. For many self-employed individuals, the tax equals or exceeds their federal income tax bill. And yet, the Social Security tax gets little attention. And what about the impact of inflation? Let’s discuss.
How big can my Social Security tax bill be?
Probably a lot bigger than you think. As an employee, your wages are hit with the 12.4% Social Security tax up to the annual wage ceiling. Half the Social Security tax bill (equal to 6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer, so you never actually see the second half. Unless you understand how the Social Security tax works and closely examine your pay statements, you may be blissfully unaware of how much the tax actually costs. Potentially a lot! Here’s why.
The Social Security tax wage ceiling for 2022 is $147,000. If your wages meet or exceed this year’s ceiling, the Social Security tax hit for this year will be a whopping $18,228 (12.4% x $147,000 = $18,228). Ouch. Half of that comes out of your paychecks. Your employer pays the other half.
The wage ceiling is projected to rise to $155,100 next year. The projected future-year increases are shown later in this column.
What if I’m self-employed?
While many employees may be unaware of the full magnitude of the Social Security tax, because they only pay half the bill, self-employed folks (sole proprietors, partners, and LLC members) know the unmitigated truth all too well. That’s because self-employed individuals must pay the entire 12.4% Social Security tax hit out of their own pockets, based on their net self-employment income. The fact that companies don’t owe any Social Security tax on amounts paid to independent contractors is a big reason why they often prefer to engage independent contractors instead of hiring employees.
For 2022, the Social Security tax self-employment income ceiling is $147,000 (same as the wage ceiling for employees). So if your net self-employment income for this year is $147,00 or more, you’ll get socked with the maximum $18,228 Social Security tax hit (12.4% x $147,000). You’re welcome.
How much will the Social Security tax ceiling increase in future years?
Good question. The Social Security tax hit on your 2022 income is expensive enough, but it’s only going to get worse in future years. Much worse. That’s because the Social Security tax ceiling will continue to go up based on the inflation factor that’s used to justify the increases. In turn, maximum Social Security tax bills for high earners will go up. The recently-announced Social Security Administration (SSA) projections for the 2023-2030 Social Security tax ceilings are shown below, based on the so-called intermediate case numbers.
* $155,100 for 2023.
* $165,300 for 2024.
* $173,400 for 2025.
* $180,600 for 2026.
* $188,100 for 2027.
* $195,600 for 2028.
* $203,100 for 2029.
* $210,600 for 2030.
Ugh. These guesstimated ceilings are bad enough. Could they get worse? Absolutely, if inflation is higher than projected. That would not be a shocker, right? But let’s say the projected numbers play out. If so, the maximum Social Security tax hit on wages and self-employment income in 2030 will be a whopping $26,114 (12.4% x $210,600). OMG.
Why the disconnect between Social Security tax ceiling increases and Social Security benefit increases?
Another good question. Don’t think that annual increases in the Social Security tax ceiling are linked to annual Social Security benefit increases. Common sense dictates that they should be linked, but they are not. For example, the 2017 Social Security tax ceiling was 7.3% higher than the 2016 ceiling, but benefits went up by only 0.3% in 2017. The alleged reason is that different inflation measures are used for the two calculations. The annual increase in the Social Security tax ceiling is supposedly based on the increase in average wages. But I’m pretty sure average wages did not go up by anything close to 7.3% in 2017. So, there’s funny business going on here. But as long as the citizenry doesn’t complain, the funny business will continue. All that said, some pundits are predicting that Social Security benefits will go up by 10% or 11% next year. If so, maybe we’ll get a one-year break from the funny business. Fingers crossed.
There’s a Social Security benefit account with my name on it, right?
No. Some people think the government has set up an account with their name on it to hold the money to pay for their future Social Security benefits. After all, that must be where all those Social Security taxes on people’s wages and self-employment income go. Right? Wrong. There are no individual accounts. All you have is a “promise” from the government, for what it’s worth.
Is the Social Security system financially solid?
In my opinion, no. It’s on shaky ground. Our beloved D.C. politicians have known that for years and done nothing about it. The SSA projects that the Social Security trust fund will become insolvent in 2034. So, additional Social Security tax hikes in the form of higher rates or some tax-law contortion that effectively implements higher ceilings (or both) are probably more likely than not. Terrific.
More bad news
Per the above, some of our beloved D.C. politicians have floated a tax-law change that would restart the 12.4% Social Security tax on salaries and self-employment income above $400,000. This is the so-called donut hole approach to increasing the Social Security tax. Over the years, the donut hole would gradually close as the lower edge of the hole is adjusted upward for inflation while the $400,000 upper edge of the hole remains fixed.
The bottom line
It’s not a pretty picture folks. The Social Security tax hits on many individuals will continue to go up (maybe way up), and the odds of actually receiving the benefits you’ve been promised are dicey. Sad but true.