2021 Wage Cap Rises for Social Security Payroll Taxes

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.

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.

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

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.

[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)

Married Filing Jointly (and surviving spouse)

Married Filing Separate Returns

Heads of Households

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]

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