Update: The social security tax ceiling for 2008 is $102,000.
This little nugget of information is potentially useful for pretty much anyone earning a wage, but it’s especially important for those of us that are earning self-employment income. In case you weren’t aware, everytime you pay Social Security or Medicare taxes at your regular job (assuming you have one), your employer pays an equal amount on your behalf. But if you’re self-employed, you get to pay both shares yourself. And were not talking about a trivial amount of money, either. Social Security taxes currently stand at 6.2%, with Medicare adding another 1.45%. So self-employment income is subject to a 15.3% hit in addition to plain old income taxes. It’s not pretty.
But here’s the good news… If you make enough money, the Social Security part of that equation goes away. That’s right, in 2006 your Social Security taxes are capped such that you only pay on your first $94,200 of income (it was $90,000 in 2005, and climbs to $97,500 in 2007). In my case, I’ll clear the bar based on my day job, which means that I’ll be able to avoid the the vast majority of self-employment tax on my other earnings. The reason that I won’t be able to avoid it entirely is that there’s no ceiling on the Medicare portion. Thus, I’ll still have to pay 2.9% (1.45% x 2) in addition to the plain old income taxes that I’ll owe.
Here’s another tip… If you worked more than one job during the year (as I did) it’s possible that you’ve overpaid your Social Security taxes… So when you get your W-2 forms, add up the values in Box 4 on each. If the total exceeds $5,840.40 (6.2% of $94,200) then you’re due a refund. The only catch is that you have to file IRS From 1040 (not 1040A or 1040EZ) to claim the overpayment.
And if you’re not currently in a position to benefit from this tax break, keep it in mind as you work your way up the payscale — it’s definitely something to shoot for.
Hat tip to FMF of FreeMoneyFinance for pointing out this ceiling to me the other day in an e-mail exchange about taxes.