Personal Finance

In Just 1 Month, Millionaires Will Be Done Paying This Tax

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No one likes paying taxes, but there are plenty of different kinds of taxes most people can't avoid. On top of the income tax returns that you'll be preparing in the months ahead, workers also pay payroll taxes on their earnings. A big chunk of that money goes toward funding Social Security benefits, and the wages on which you pay those taxes count toward determining how much money you'll get from Social Security when you retire.

Nearly everyone who gets wage income pays Social Security tax , but something many people don't know is that there's an upper limit on how much tax a worker has to pay each year. What that means for people who have annual earnings of $1 million is that they effectively stop having to pay the Social Security portion of their payroll taxes less than 49 days into the year. By Feb. 18 -- a month from this article's publish date -- those high-income earners will be done paying taxes that tens of millions of workers pay all year long.

Four smiling people on a yacht at sea.

Image source: Getty Images.

The basics of Social Security payroll taxes

The vast majority of money that Social Security uses to pay its benefits comes from payroll tax withholding . Currently, the federal government charges a 6.2% tax on your earnings, which your employer is required to take out of your paycheck. There's also an employer portion of the payroll tax that requires a matching 6.2% contribution directly from your employer's pocket. Those who are self-employed end up paying the total of 12.4%.

But above a certain level o f earnings , the government stops collecting that 6.2% tax. The amount, which is called the wage base, is adjusted for inflation every year. The figure for 2019 is $132,900 . That's up from $128,400 in 2018, and it means that the maximum amount of tax that employers will withhold for Social Security payroll tax is 6.2% of $132,900, or $8,239.80. Beyond that $132,900, any further earnings don't get reduced by Social Security tax withholding.

If your earnings exceed the wage base, then at some point during the year, you'll max out on Social Security payroll tax. After that, your paychecks will get bigger. For those who make $1 million a year, that day comes 13.29% of the way through the year. That works out to 48.5 days -- which means that on Feb. 18, millionaire earners reach the point at which they no longer have to pay anything toward Social Security taxes.

Should millionaires pay more?

The way that Social Security taxes work doesn't match up with how most federal taxation operates. For income tax, a progressive tax structure ensures that low-income earners pay relatively low tax rates, while those who earn more pay higher tax rates. Under tax reform, the rate structure starts at 10% and climbs to 37%.

By contrast, payroll taxes work the opposite. Workers pay 6.2% from the first dollar of earnings, but the effective tax rate on millionaire earners from Social Security taxes is just 0.82%. That makes payroll taxes regressive -- hitting low-income earners harder than those with high incomes.

Historically, the government has made changes to eliminate similar issues. Medicare tax withholding used to work the same way, with maximum wages on which the tax was imposed. But that changed in the 1990s, and now, the 1.45% Medicare payroll tax gets withheld from earnings no matter how high they are.

For Social Security, though, some oppose boosting the wage base . Right now, the maximum wage base also establishes maximum Social Security benefits. Take away the wage base limitation, and you either have to boost maximum benefits or make changes that effectively destroy the link between taxable earnings and benefits. Neither of those outcomes is ideal, even though proponents of taking the wage base limit away point to the potential for additional tax revenue that could shore up Social Security's financial health.

A rising voice for change won't have an immediate impact

With a new Congress in session, there'll inevitably be efforts to boost payroll taxes, but they're unlikely to get through both the House and Senate -- let alone get signed into law by the White House. As a result, millionaires can count on enjoying the last 10 and a half months of 2019 without any Social Security tax on their earnings -- even as those who make less than $132,900 keep paying them all year long.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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