Confusion over Social Security taxes and earning limits

There seems to be great confusion among older workers about whether they’re still subject to Social Security payroll taxes once they reach a certain age or begin receiving retirement benefits.

Case in point: Al Lindsten, a financial adviser with Shelton Financial in Fort Wayne, Indiana, said he has a client who’s 70, recently began collecting his maximum Social Security benefit and works part-time earning about $3,000 per year as an announcer for local football and basketball games.

Lindsten’s question: Does the client’s employer need to withhold FICA taxes from his paycheck now that he’s receiving Social Security benefits?

While it may seem like a classic case of what-one-hand-giveth-the-other-taketh-away, Uncle Sam still wants his share of your payroll taxes, regardless of your age or whether you are currently collecting Social Security benefits.

Employees and employers each contribute 7.65% of the first $147,000 of gross earnings in 2022. The bulk of that FICA tax — 6.2% — funds Social Security benefits. The balance —1.45% — applies to all wages, even those above $147,000, and helps fund Medicare. Self-employed individuals pay both shares of the payroll tax for a combined rate of 15.3% on net self-employment income.

If the sports announcer is a contractor and receives 1099 income, rather than an employee who receives a W-9 statement for income tax purposes, he may be responsible for paying his own estimated taxes each quarter. Or he may find it easier to have Social Security withhold a portion of his benefits for taxes. For more information, read the IRS’ Tax Guide for Seniors.

While there’s no age limit on paying FICA taxes, there is an age limit on the earnings restrictions that can temporarily reduce — or even eliminate — Social Security benefits if individuals claim benefits before their full retirement age and continue to work. That’s most likely the source of the client’s confusion as to whether he’s still subject to payroll taxes due to his age and benefits status.

In 2022, people who are under their full retirement age for the entire year temporarily lose $1 in benefits for every $2 earned over $19,560. In the year individuals reach their full retirement age, there is a much higher earnings test.

Social Security beneficiaries who reach their full retirement age of 66 and four months during 2022 can earn up to $51,960 during the months before their full retirement age. If their earnings exceed that limit, they forfeit $1 in benefits for every $3 earned over that limit.

Once someone reaches full retirement age, the earnings restrictions disappear, meaning they can earn as much money as they like without jeopardizing any of their Social Security benefits. At that point, Social Security automatically recalculates their benefit to restore any benefits lost due to excess earnings in the form of higher future monthly benefits.

A related issue that confuses some retirees is whether they must pay income taxes on their Social Security benefits once they reach a certain age. Depending on their income, the answer is a definitive yes.

Since 1984, Social Security beneficiaries with total income exceeding certain thresholds have been required to claim part of their Social Security benefits as taxable income. The income thresholds have remained unchanged since Congress first established them but, because Social Security benefits have increased over the years as a result of annual cost-of-living adjustments, the proportion of beneficiaries who must pay federal income tax on their benefits has risen over time.

In 1984, less than 10% of beneficiaries paid federal income tax on their benefits. Today, about 40% of Social Security beneficiaries pay taxes on a portion of their benefits.

If you file an individual federal tax return and your combined income is between $25,000 and $34,000, you may have to pay taxes on up to half of your Social Security benefits. If your combined income is more than $34,000, up to 85% of your Social Security benefits is subject to income tax.

If you are married and file a joint return, you may have to pay taxes on up to half of your benefits if you and your spouse have a combined income between $32,000 and $44,000. If your combined income is more than $44,000, up to 85% of your Social Security benefits is subject to income tax. If you’re married and file a separate return, you’ll probably pay taxes on your benefits.

Combined income is defined as the sum of your adjusted gross income plus nontaxable interest plus half of your Social Security benefits.

(Questions about new Social Security rules? Find the answers in Mary Beth Franklin’s new 2022 ebook at Maximizing Social Security Benefits)