How Social Security Tax Works

15.3 Percent, Any Way You Cut It

As of 2010, the government takes 15.3 percent out of every working American's paycheck for Social Security taxes -- including both Social Security and Medicare. If you're an employee, half of that amount is deducted from each and every paycheck. The other half is paid directly by your employer, which means that other half is essentially coming out of your pay as well. The difference is, the half your employer pays isn't considered part of your income, so it doesn't count toward the amount of Social Security tax you pay, nor does it count toward your income taxes.

If you're self-employed, you pay the entire 15.3 percent yourself, either at the end of the year when taxes are due or in quarterly payments throughout the year. However, you get to deduct half of that amount when you calculate your income taxes, so you get the same tax benefit as if an employer had paid it.

Where does the 15.3 percent rate come from? It's made up of the 12.4 percent that goes to Social Security and the 2.9 percent reserved for Medicare. That rate is set by the Federal Insurance Contributions Act (FICA). FICA includes measures to reflect inflation of cost-of-living increases (COLA) automatically, so Congress doesn't have to pass or amend the law every time the amount needs to change. Social Security benefits increase to keep pace with COLA according to the Consumer Price Index for Urban Wage Earners and Clerical Workers [source:]. Social Security taxes, in turn, increase along with inflation by raising the income cap according to average national wages.

The income cap is the maximum amount of income subject to Social Security taxes. There's no cap on Medicare taxes. The official term for this cap is the Social Security Wage Base. In 2010, this cap was $106,800. What the cap means is that you pay your half of the 12.4 percent (or the whole thing if you're self-employed) only on the first $106,800 you make. Any income above that level isn't subject to Social Security taxes. If you're an employee who earned $106,800 in 2009, you'll pay $6,621.60 in Social Security taxes. Your employer pays that same amount. If you earned $50 million in 2009, you'll still pay $6,621.60 in Social Security taxes. Since wages tend to rise (gradually) due to inflation, tying the cap to average wages roughly allows the amount of Social Security taxes collected to stay on par with inflation.

Of course, the full story of Social Security taxes isn't quite that simple. Next, we'll look at exceptions, exemptions and other situations where the tax rate isn't so clear-cut.