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Social Security reform may mean less pay
Here's how high earners' paychecks may change if more wages are subject to a Social Security tax.
May 20, 2005: 3:26 PM EDT
By Jeanne Sahadi, CNN/Money senior writer
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NEW YORK (CNN/Money) – In the latest rounds of the Social Security debate, one element that has gained traction is lifting the cap on the amount of wages subject to a payroll tax.

Such a move would go some way toward making up for the system's projected shortfalls -- and likely would be used in combination with other measures.

It would also take more out of the paychecks of higher income workers, especially those who are self-employed (i.e., sole proprietors or freelancers).

Currently, the first $90,000 of your wages is subject to a 12.4 percent Social Security tax. Employees pay half (6.2 percent), while employers pick up the other half. If you're self-employed, you pay the full 12.4 percent, but you can get some of it back by deducting the employer portion on your federal tax return.

President Bush has said repeatedly he would oppose any increase in the payroll tax rate (12.4 percent). But he has not ruled out raising the cap on the amount of wages subject to a Social Security tax.

Meanwhile, two more specific wage-cap proposals have been made.

Robert Pozen, the chairman of MFS Investments who has proposed that Social Security benefits be progressively indexed -- a move the president supports -- has suggested subjecting wages above $90,000 to a 2.9 percent surtax, half paid by employees and half paid by employers.

Pozen suggested that the employee portion of the tax could go into an IRA if the worker chose.

Rep. Robert Wexler (D-Fla.) has suggested imposing a 6 percent tax on all wage income above $90,000 – again, with employers picking up half the tab.

Either of these proposals (or ones like them) would increase the Social Security tax bite on those making more than $90,000 in wages. But it might not affect them equally. Unless adjustments are made, much will depend on their marital status, whether they live in a one- or two-earner household, and whether they own their own business.

How much extra would you pay?

CNN/Money asked tax information publisher CCH, Inc. to crunch some numbers demonstrating how high-income taxpayers would fare under the Pozen plan, the Wexler plan and a hypothetical plan that would raise the wage cap to $150,000.

Take, for example, a two-earner household where each spouse earns $100,000 for a total of $200,000 in wages. Under the Pozen plan, they would pay an additional $290 combined.

If that same couple were a one-earner household pulling in the same $200,000, they would pay an additional $1,595.

Here's why there's such a big difference: Under the Pozen plan, employees and employers would split a 2.9 percent tax on any wages over $90,000. So when each spouse earns $100,000, they would each pay 1.45 percent on the extra $10,000. But if only one spouse earns the full $200,000, he or she pays 1.45 percent on $110,000.

Meanwhile, single taxpayers under the Pozen plan would pay an additional $145 if they made $100,000, and an additional $1,595 if they made $200,000.

Under the Wexler plan, the two-earner household where each spouse makes $100,000 would pay an additional $600. If only one spouse earned that $200,000, they would pay an extra $3,300.

For singles under the Wexler plan, they'd pay an extra $300 if they make $100,000 or an extra $3,300 if they earned $200,000.

Under a plan where the wage cap is raised to $150,000 – meaning the first $150,000 of wages would be subject to the 12.4 percent payroll tax, half paid by the worker – a two-earner household would pay an additional $1,240 assuming each spouse makes $100,000.

But a one-earner couple making that same $200,000 would pay an extra $3,720.

Meanwhile, singles making $100,000 would pay an extra $620, but an extra $3,720 if they earned $200,000.

In each of these scenarios, the extra tax that one-earner couples would pay is considerably higher than that of two-earner couples. But overall, the one-earner family would still pay less into Social Security. That's because they pay $5,580 on the first $90,000 of their wages, while the two-earner family pays double that -- $11,160 -- since each spouse must pay $5,580 on the first $90,000 of his or her wages.

What's the effect on income taxes?

Paying more in Social Security taxes would not affect the income tax picture for employees making more than $90,000 in wages, according to CCH.

For small business owners, however, since they pay both the employee and employer portion of any Social Security tax, they will pay more out-of-pocket than a wage earner who is not self-employed.

But if small business owners' wages above $90,000 are subjected to a Social Security tax, that could lower their adjusted gross income (AGI). That's because an increase in their Social Security tax means they will be able to take a larger above-the-line deduction on their 1040s to reflect the employer portion of the tax that they paid.

"That could have some effect on your eligibility for other tax breaks," said Mark Luscomb, a tax expert at CCH. "In general, it would be a good thing for your AGI."

That's because your AGI is often key in determining whether you qualify for various tax credits and deductions. And a lower AGI typically means you're more likely to qualify for those breaks.

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To learn more about what changes to the wage cap might mean, click here.  Top of page

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