Social Security

March 13, 2024

8570 / What are the Social Security tax and Medicare rates for self-employed taxpayers?

<div class="Section1">Similar to the FICA tax imposed on wage income, Social Security and Medicare taxes are imposed on self-employment income pursuant to the Self-Employment Contributions Act of 1954 (collectively, the two taxes are more formally referred to as the “SECA tax”).<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> Unlike a wage earner whose liability is limited to one-half of the FICA tax, a self-employed individual is obligated to pay the entire amount of the 15.3 percent SECA tax, or 12.4 percent Social Security tax and 2.9 percent Medicare tax. Similar to FICA, the Social Security tax cap for self-employment income is the same dollar amount as the Social Security wage cap. Indexed for inflation, for 2025, the Social Security cap for self-employment income is $176,100.<a href="#_ftn2" name="_ftnref2">2</a> On the other hand, there is no cap on the amount of self-employment income subject to the Medicare tax. Moreover, effective for tax years beginning after December 31, 2012, subject to filing status thresholds, there is an additional Medicare surtax of 0.9 percent added to the 2.9 percent Medicare tax rate (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8657">8657</a>). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  SECA is codified as Chapter 2 of the Internal Revenue Code. <a href="#_ftnref2" name="_ftn2">2</a>.  www.socialsecurity.gov. </div></div>

March 13, 2024

8568 / Are Social Security and railroad retirement benefits taxable?

<div class="Section1">A taxpayer must include a portion of benefits in gross income if the taxpayer’s modified adjusted gross income (in most cases the taxpayer’s adjusted gross income) plus one-half of the Social Security benefits (including tier I railroad retirement benefits) received during the taxable year exceeds certain base amounts. The amounts that are required to be included in gross income are taxed as ordinary income. As the taxpayer’s income in addition to Social Security benefits increases, so does the amount of those benefits that are taxable. However, the amount of benefits that are taxable can never exceed 85 percent of the total benefits received by the taxpayer.</div> To calculate the extent to which Social Security benefits are taxable, add one-half of Social Security benefits received during the tax year to all other income including wages, interest (including tax exempt interest), dividends, taxable pension distributions, etc. (modified adjusted gross income).<a href="#_ftn1" name="_ftnref1">1</a> Next, compare that amount with the applicable base amounts, which are the following: <div class="Section1"> <blockquote>$25,000 for taxpayers filing as single, head of household or qualifying widow(er)s; $25,000 for married taxpayers who file separately and live apart from the other spouse for the entire tax year; $32,000 for married taxpayers filing jointly; or $0 for married taxpayers who file separately, but live with a spouse at any time during the tax year.<a href="#_ftn2" name="_ftnref2">2</a></blockquote> If the modified adjusted gross income plus one-half of Social Security benefits is equal to or less than the base amount, no portion of the Social Security benefits are taxable. On the other hand, if the sum of modified adjusted gross income plus one-half of Social Security benefits exceeds the base amount, then a portion of those benefits are potentially taxable. The computation, however, involves the “adjusted base amount” which is the following: <blockquote>$34,000 for all filers with the exception of joint filers and a married taxpayer that both files separately and lives with his or her spouse at any time during the tax year. $44,000 for joint filers. $0 for a married taxpayer who files separately and lives with his or her spouse at any time during the taxable year.<a href="#_ftn3" name="_ftnref3">3</a></blockquote> If the sum of modified adjusted gross income plus one-half of Social Security benefits is greater than the base amount but less than the adjusted base amount, the amount included in gross income is the lesser of 1) one-half of the Social Security benefits received during the tax year; or 2) one-half of the excess of the sum of modified adjusted gross income plus one-half of the amount of Social Security benefits that exceeds the base amount (referred to as the “Section 86(a)(1) Amount”).<a href="#_ftn4" name="_ftnref4">4</a> <blockquote>  Example: A married couple files a joint return. During the taxable year, they received $12,000 in Social Security benefits and have a modified adjusted gross income of $35,000. Their modified adjusted gross income plus one-half of their Social Security benefits [$35,000 + (½ of $12,000) = $41,000] is greater than the base amount of $32,000 but less than the adjusted base amount of $44,000.</blockquote> So in computing the taxable amount of Social Security benefits, consider the following: the taxpayers’ Social Security benefits are $12,000 and the excess of (1) modified adjusted gross income plus one-half of their Social Security benefits over (2) the base amount is equal to $9,000 ($41,000 minus $32,000). However, referring back to the formula, the amount includible is one-half of the lesser amount. Therefore, the amount of Social Security benefits included in gross income is $4,500 (one-half of $9,000) because it is less than $6,000 (one-half of the $12,000 total Social Security benefits). If the sum of modified adjusted gross income plus one-half of Social Security benefits is greater than the adjusted base amount, the amount included in gross income is the lesser of the sum of 1) 85 percent of the amount of modified adjusted gross income over the adjusted base amount plus the lesser of (a) the Section 86(a)(1) Amount or (b) one-half of the difference between the adjusted base amount and the base amount or 2) 85 percent of the Social Security benefits received during the tax year. <blockquote>  Example: During the taxable year, a single individual had a modified adjusted gross income of $33,000 and received $8,000 in Social Security benefits. His modified adjusted gross income plus one-half of his Social Security benefits [$33,000 + (½ of $8,000) = $37,000] is greater than the applicable adjusted base amount of $34,000. <blockquote>So tracking the formula above: the lesser of 1) 85 percent of the amount of modified adjusted gross income over the adjusted base amount of $3,000 ( $37,000 (modified adjusted gross income) minus the $34,000 adjusted base amount), or $2,550, plus the lesser of a) the Section 86(a)(1) amount of $6,500 (which is one-half of $13,000, i.e., the excess of $37,000 (modified adjusted gross income) over the base amount of $24,000) or b) $4,500 (which is one-half of $9,000, the difference between the $34,000 adjusted base amount and the $25,000 base amount); or 2) 85 percent of total Social Security benefits of $8,000, or $6,800. So consolidating the above formula, 85 percent of $3,000, or $2,550 plus $4,500, equals $6,550 which is less than 85 percent of $8,000, or $6,800. Therefore, the amount included in gross income is $6,550.</blockquote> </blockquote> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 86(b)(2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 86(c)(1). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 86(c)(2). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 86(a)(1). </div>

March 13, 2024

8569 / What other issues relate to the taxation of Social Security and railroad retirement benefits?

<div class="Section1"> Railroad retirement benefits (other than Tier I benefits) are taxed like benefits received under a qualified pension or profit sharing plan. For this purpose, the Tier II portion of the taxes imposed on employees and employee representatives is treated as an employee contribution, while the Tier II portion of the taxes imposed on employers is treated as an employer contribution.<a href="#_ftn1" name="_ftnref1">1</a> As mentioned in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8568">8568</a>, the base amount and adjusted base amount of a married taxpayer filing separately who lives with his or her spouse at any time during the tax year is zero. This means it is much more likely that 85 percent of his or her Social Security benefits will be taxable even if the other income is relatively low. As a result, the issue of whether separated taxpayers are living apart is significant. To address this point, the Tax Court has held that the term “live apart” means living in separate residences for purposes of IRC Section 86(c)(1)(C)(ii). Thus, where the taxpayer lived in the same residence as his spouse for at least 30 days during the tax year in question (even though maintaining separate bedrooms), the Tax Court ruled that he did not “live apart” from his spouse at all times during the year; therefore, the taxpayer’s base amount was zero.<a href="#_ftn2" name="_ftnref2">2</a> A taxpayer may elect to treat a lump sum payment of benefits as received in the year in which the benefits are attributable.<a href="#_ftn3" name="_ftnref3">3</a> Any workers’ compensation pay that reduced the amount of Social Security received and any amounts withheld to pay Medicare insurance premiums are included in the figure for Social Security benefits.<a href="#_ftn4" name="_ftnref4">4</a> Another issue that has arisen is whether Social Security disability payments should be lumped in with regular Social Security benefits in determining whether the benefits are taxable. In Green v. Commissioner,<a href="#_ftn5" name="_ftnref5">5</a> the taxpayer argued that his Social Security disability benefits were excludable from gross income<a href="#_ftn6" name="_ftnref6">6</a> because they had been paid in lieu of workers’ compensation. The Tax Court determined, however, that Title II of the Social Security Act is not comparable to workers’ compensation, which provides benefits based on a taxpayer’s employment. Instead, the Act allows for disability payments to individuals regardless of employment. Consequently, the taxpayer’s Social Security disability benefits were includable in gross income. In a case of first impression, the Tax Court held that a taxpayer’s Social Security disability insurance benefits (payable as a result of the taxpayer’s disability due to lung cancer that resulted from exposure to Agent Orange during his Vietnam combat service) were includable in gross income under IRC Section 86 and were not excludable under IRC Section 104(a)(4). The court reasoned that Social Security disability insurance benefits do not take into consideration the nature or cause of the individual’s disability. Furthermore, the Social Security Act does not consider whether the disability arose from service in the Armed Forces or was attributable to combat-related injuries. Eligibility for purposes of Social Security disability benefits is determined on the basis of the individual’s prior work record, not on the cause of disability. Moreover, the amount of Social Security disability payments is computed under a formula that does not consider the nature or extent of the injury. Consequently, because the taxpayer’s Social Security disability insurance benefits were not paid for personal injury or sickness in military service within the meaning of IRC Section 104(a)(4), the benefits were not eligible for exclusion under IRC Section 104(a)(4).<a href="#_ftn7" name="_ftnref7">7</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 72(r)(1). <a href="#_ftnref2" name="_ftn2">2</a>.  McAdams v. Commissioner, 118 TC 373 (2002). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 86(e). <a href="#_ftnref4" name="_ftn4">4</a>.  Rev. Rul. 84-173, 1984-2 CB 16. <a href="#_ftnref5" name="_ftn5">5</a>.  TC Memo 2006-39. <a href="#_ftnref6" name="_ftn6">6</a>.  Under IRC § 104(a)(1). <a href="#_ftnref7" name="_ftn7">7</a>.  Reimels v. Commissioner, 123 TC 245 (2004), aff’d, 436 F.3d 344 (2d Cir. 2006); Haar v. Commissioner, 78 TC 864, 866 (1982), aff’d, 709 F.2d 1206 (8th Cir. 1983), followed. </div></div>

March 13, 2024

8571 / What are the Social Security and Medicare tax rates for traditional employees and employers?

<div class="Section1">The Social Security tax and Medicare tax rates that apply to the wage income of a wage earner are the same as those applicable to the self-employment income of a self-employed individual. However, the operative statute for the imposition of payroll taxes on wage earners is the Federal Insurance Contributions Act (the “FICA tax”).<a href="#_ftn1" name="_ftnref1">1</a> Unlike the self-employed, the liability for FICA tax imposed on the wages of a wage earner is split equally between the employee and the employer. In other words, the employee and the employer are each responsible for 6.2 percent of the 12.4 percent of Social Security tax and for 1.45 percent of the 2.9 percent of Medicare tax.<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> Although the Social Security tax rate is much higher than the Medicare tax rate, it only applies to wages that do not exceed the earnings cap (as adjusted annually for inflation). Therefore, wages in excess of the cap amount are not subject to Social Security tax. For 2025, the Social Security tax does not apply to wages in excess of $176,100 (the amount was $168,600 in 2024).<a href="#_ftn3" name="_ftnref3">3</a> Thus, the maximum amount of Social Security tax liability for the combined employee and employer share is $21,836.40 (12.4% * $176,100), or $10,918.20 each. On the other hand, there is no cap on the Medicare tax. This means the combined employer/employee 2.9 percent tax rate will be imposed on all wages without limit. Therefore, for 2025, although the imposition of Social Security tax ceases to apply to wages in excess of $176,100, the Medicare tax continues to be imposed on all wages. Moreover, effective for tax years beginning after December 31, 2012, there is an additional Medicare surtax of 0.9 percent added to the 1.45 percent rate on the employee portion of the Medicare tax for certain high-income taxpayers (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8657">8657</a>). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">[1]</a>.     Codified as Chapter 21 of the Internal Revenue Code, IRC §§ 3101-3128. <a href="#_ftnref2" name="_ftn2">[2]</a>.     IRC §§ 3101(a), 3111(a), 3101(b) and 3111(b). <a href="#_ftnref3" name="_ftn3">[3]</a>.     www.socialsecurity.gov. </div></div>