2021 Wage Cap Rises for Social Security Payroll Taxes

Starting Jan. 1, 2021, the maximum earnings subject to the Social Security payroll tax will…

Starting Jan. 1, 2021, the maximum earnings subject to the Social Security payroll tax will increase by $5,100 to
$142,800—up from the $137,700 maximum for 2020,
the Social Security Administration (SSA) announced Oct. 13. The
SSA also posted a fact sheet summarizing the 2021 changes.

The taxable wage cap is subject to an automatic cost-of-living adjustment (COLA) each year based on increases in the national average wage index, calculated annually by the SSA.


Payroll Taxes: Cap on Maximum Earnings


Type of Payroll Tax


2021 Maximum Earnings


2020 Maximum Earnings

Social Security

$142,800

$137,700

Medicare

No limit

No limit

Source: Social Security Administration.

The growth of the Social Security wage cap from $118,500 in 2016 to 142,800 in 2021 represents more than a 20 percent increase over the past five years.

FICA Rates

Social Security and Medicare payroll taxes are collected together as the Federal Insurance Contributions Act (FICA) tax. FICA tax rates are statutorily set and can only be changed through new tax law.

Social Security is financed by a 12.4 percent payroll tax on wages up to the taxable earnings cap, with half (6.2 percent) paid by workers and the other half paid by employers. Self-employed workers pay the entire 12.4 percent.

For employers and employees, the Medicare payroll tax rate is a matching 1.45 percent on all earnings (self-employed workers pay the full 2.9 percent), bringing the total Social Security and Medicare payroll withholding rate for employers and employees to 7.65 percent—with only the Social Security portion limited to the taxable maximum amount.

FICA Rate (Social Security + Medicare Withholding)
Employee 7.65%
(6.2% + 1.45%)
​Employer ​7.65%
(6.2% + 1.45%)
​Self-Employed ​15.3%
(12.4% + 2.9%)
Note: For employed wage earners, their Social Security portion is 6.2% on earnings up to the taxable maximum. Their Medicare portion is 1.45% on all earnings.

The payroll tax rates shown above do not include
an additional 0.9 percent in Medicare taxes paid by highly compensated employees on earnings that exceed threshold amounts based on their filing status:

  • $250,000 for married taxpayers who file jointly.
  • $125,000 for married taxpayers who file separately.
  • $200,000 for single and all other taxpayers.

These wage thresholds, set by law, do not adjust for inflation and therefore apply to more employees each year.

Employers must withhold the additional Medicare tax from wages of employees earning more than $200,000 in a calendar year.

Some Payroll Taxes Suspended Due to COVID-19

In response to the COVID-19 pandemic, relief was put into place affecting payroll withholding for Social Security FICA taxes in 2020.

  • The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law in March and implemented through
    IRS Notice 2020-22 and a series of
    IRS FAQs, allows eligible employers to defer the deposit and payment of the
    employer’s share of Social Security FICA taxes from March 27 through Dec. 31, 2020. The deferred payments must then be paid to the Treasury Department, with half due by Dec. 31, 2021, and the other half by Dec. 31, 2022.
  • IRS
    Notice 2020-65, issued on Aug. 28, allows employers to suspend withholding and paying to the IRS eligible
    employees’ Social Security payroll taxes. The payroll tax suspension period
    runs from Sept. 1 through Dec. 31, 2020, and applies only to employees whose wages are less than $4,000 for a biweekly pay period, including salaried workers earning less than $104,000 per year.

Companies that suspend withholding of employees’ payroll tax would collect additional amounts from workers’ paychecks from Jan. 1 through April 30, 2021, to repay the tax obligation. Only a small percentage of private-sector employers appear to have suspended employees’ Social Security tax withholding, however. [Update: The
Consolidated Appropriations Act that President Trump signed at the end of 2020 extended the repayment period through Dec. 31, 2021. Now, penalties and interest on deferred unpaid tax liability will not begin to accrue until Jan. 1, 2022.]

Adjust Systems, Notify Employees

Employees whose compensation exceeds the current 2020 taxable earnings cap of $137,700 may notice a slight decrease in net take-home pay beginning next January due to the payroll tax adjustment.

By the start of the new year, U.S. employers should:

  • Adjust their payroll systems to account for the higher taxable wage base under the Social Security payroll tax.
  • Notify affected employees that more of their pay will be subject to payroll withholding.

Social Security Earnings Test COLA

Workers can start to collect Social Security retirement benefits as early as age 62, but their monthly payment will be lower than if they wait until
their normal retirement age—age 66 for people born in 1943 through 1954, for instance.

In addition, those who collect Social Security before their full retirement age but continue to earn income will have their monthly benefits reduced if their earnings exceed an annually adjusted earnings test limit:

  • For those collecting benefits in 2021 before their full retirement age, the SSA will deduct $1 from their monthly benefits for each $2 earned over $18,960 per year (or $1,580 per month), up from $18,240 per year (or $1,520 per month) in 2020.
  • For those reaching their full retirement age in 2021, the SSA will deduct $1 from their monthly benefits for each $3 earned over $50,520 per year (or $4,210 per month) until the month in which the worker reaches full retirement age, up from $48,600 per year (or $4,050 per month) in 2020.

There is no limit on earnings under this test for workers who have reach or passed their full retirement age for the entire year.

Social Security Benefits COLA

Monthly Social Security and Supplemental Security Income benefits for more than 64 million people in the U.S. will increase by 1.3 percent in 2021, the SSA also announced.

“[The] announcement of a 1.3 percent COLA increase—while modest—is needed to help Social Security beneficiaries and their families try to keep up with rising costs,” said AARP Chief Executive Officer Jo Ann Jenkins. “The guaranteed benefits provided by Social Security and the COLA increase are more crucial than ever as millions of Americans continue to face the one-two punch of the coronavirus’s health and economic consequences.” 

Explained A.J. Johnson Consulting Services, “the SSA calculates the percent change between average prices in the third quarter of the current year with the third quarter of the previous year;
that’s why the final number comes out in October.” The SSA “ties its adjustment for Social Security benefits to the wage earners’ consumer price index, which is similar to, but not the same as, the urban dwellers’ consumer price index (which drives inflation reporting).”

The consultancy noted, “There have been three years (2010, 2011, and 2016) with no COLA increase. Since 2009, the average COLA has been 1.75 percent with the highest being 5.8 percent in 2009.”

Slight Increase to Full Retirement Age

The full Social Security retirement age—when beneficiaries can collect 100 percent of their monthly benefit—increases by two months to 66 years and 10 months in 2021. The full retirement age will increase another two months to 67 years in 2022.

“While Americans can still claim Social Security benefits as early as 62 (and too many do),
the amount of their benefit if they do so will be 29.17 percent less than if they wait until full retirement age to claim, as the program incentivizes patience,” wrote Brian Anderson, managing editor of the website 401(k) Specialist.

Beneficiaries
who wait until age 70 to start collecting Social Security will receive 132 percent of the monthly benefit they would otherwise receive if the begin collecting benefits at their normal retirement age.

Workers can
review their future Social Security benefit amount, based on their earnings, on the SSA’s website.

HSA Wage-Deferred Contributions Exempt from Payroll Taxes

Among
employees’ common misperceptions about health savings accounts (HSAs) is a lack of awareness that payroll-deferred HSA contributions are not subject to Social Security and Medicare (FICA) and federal unemployment (FUTA) taxes. So when employees contribute to their HSA through a payroll deduction, the money is excluded from federal income taxes and FICA/FUTA taxes. 

Two states—California and New Jersey—impose state income taxes on wages contributed to HSAs. Other states
allow deductions on state income taxes for HSA contributions.

HSA funds withdrawn for qualified medical expenses are not treated as taxable income.

In comparison, with a traditional 401(k) plan account, no income taxes are deducted on employees’ payroll-deferred contributions, although FICA and FUTA taxes will be taken from amounts deferred; income taxes are then owed on withdrawals made during retirement. For a Roth 401(k) account, income and FICA/FUTA taxes are deducted from contributions, while withdrawals during retirement are tax free.

Benefit managers may want to highlight the
unique tax advantage given to HSAs in open enrollment communications about HSA-eligible health plans.


[Update]

2021 Income Tax Brackets

The IRS issued income tax bracket adjustments for tax year 2021 in
Revenue Procedure 2020-45, released on Oct. 27, 2020.

The level of income that is subject to a higher tax bracket can influence a number of decisions by employees, including how much salary to defer into a traditional 401(k) plan or into an HSA, which reduces taxable income for a given year by the amount contributed, or whether to participate in a nonqualified deferred income plan, if that option is available through the employer.

A comparison of income tax rates and ranges for 2021 and 2020 follows below. The 2021 rates are effective Jan. 1, and remain in effect through 2021 unless Congress passes new tax legislation.

Single Filing Individual Return (other than surviving spouses and heads of households)

Tax Rate 2021 Taxable Income 2020 Taxable Income
10% $0 to $9,950 $0 to $9,875
12% Over $9,500 to $40,525 Over $9,875 to $40,125
22% Over $40,525 to $86,375 Over $40,125 to $85,525
24% Over $86,375 to $164,925 Over $85,525 to $163,300
32% Over $164,925 to $209,425 Over $163,300 to $207,350
35% Over $209,425 to $523,600 Over $207,350 to $518,400
37% Over $523,600 Over $518,400

 

Married Filing Jointly (and surviving spouse)

Tax Rate 2021 Taxable Income 2020 Taxable Income
10% $0 to $19,900 $0 to $19,750
12% Over $19,900 to $81,050 Over $19,750 to $80,250
22% Over $81,050 to $172,750 Over $80,250 to $171,050
24% Over $172,750 to $329,850 Over $171,050 to $326,600
32% Over $329,850 to $418,850 Over $326,600 to $414,700
35% Over $418,850 to $628,300 Over $414,700 to $622,050
37% Over $628,300 Over $622,050

 

Married Filing Separate Returns

Tax Rate 2021 Taxable Income 2020 Taxable Income
10% $0 to $9,950 $0 to $9,875
12% Over $9,950 to $40,525 Over $9,875 to $40,125
22% Over $40,525 to $86,375 Over $40,125 to $85,525
24% Over $86,375 to $164,925 Over $85,525 to $163,300
32% Over $164,925 to $209,425 Over $163,300 to $207,350
35% Over $209,425 to $314,150 Over $207,350 to $311,025
37% Over $314,150 Over $311,025

 

Heads of Households

Tax Rate 2019 Taxable Income 2020 Taxable Income
10% $0 to $14,200 $0 to $14,100
12% Over $14,200 to $54,200 Over $14,100 to $53,700
22% Ove r$54,200 to $86,350 Over $53,700 to $85,500
24% Over $86,350 to $164,900 Ove r$85,500 to $163,300
32% Over $164,900 to $209,400 Over $163,300 to $207,350
35% Over $209,400 to $523,600 Over $207,350 to $518,400
37% Over $523,600 Over $518,400

Revenue Procedure 2020-45 also states that among other income tax adjustments for 2021:

  • The standard deduction for single taxpayers and for married taxpayers filing separately rises by $150 to
    $12,550, up from $12,400.
  • The standard deduction for married taxpayers filing joint returns rises by $300 to
    $25,100, up from $24,800.
  • The standard deduction for heads of household rises by $150 to
    $18,800, up from $18,650.

[update]

IRS Issues Updated Form W-4 for 2021

In December 2020, the IRS released the final version of the
2021 Form W-4,
Employee’s Withholding Certificate, which employees submit to their HR/payroll departments to adjust their income tax withholding for the year. 

The 2021 tax form includes only minor changes from the 2020 form, such as adjustments to the Annual Taxable Wage & Salary tables on page 4, whereas the 2020 form had undergone
a substantial revision a year earlier to allow for more-accurate withholding with greater privacy for employees.

Related SHRM Articles:

OMB Tells Agencies to Defer Federal Workers’ Payroll Taxes,SHRM Online, September 2020

Employee Social Security Tax Deferral Guidance: Too Little, Too Late?, SHRM Online, September 2020

Employers Hesitant, Confused Over Payroll Tax Suspension, SHRM Online, September 2020

IRS Guidance Allows Workers a Payroll Tax ‘Holiday,’ SHRM Online, August 2020

Related SHRM Resources:

Notice to Employees of Temporary Social Security Tax Deferral

Notice to Employees Explaining the Decision Not to Defer Social Security Tax Withholding



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