8 Sources of Income Social Security’s Payroll Tax Can’t Touch
From: www.fool.com
The payroll tax generated more than 88% of the $1 trillion collected by Social Security last year, but some forms of income got a free pass.
If you’ve ever wondered how important Social Security is to the financial well-being of our country, here’s a fact to take to heart: Each month, roughly 64 million people receive a benefit check. Of these 64 million, more than a third (22.1 million) are being pulled above the federal poverty line solely because of this guaranteed monthly payout.
It takes a lot to fund a program that divvies out 64 million checks a month, and Social Security’s 12.4% payroll tax on earned income does much of the heavy lifting. Although Social Security has three sources of income — the payroll tax on earned income, interest income on its asset reserves, and the taxation of benefits — it’s the payroll tax that was responsible for bringing in $885 billion of the $1 trillion the program collected in 2018.
Yet, you might be surprised to learn that more than $1.2 trillion in earnings “escaped” the payroll tax in 2016. In fact, the amount of earnings not subject to the payroll tax has grown from a little over $300 billion in 1983 to $1.2 trillion by 2016. The fact is that not every source of income is taxable by Social Security’s payroll tax, and it certainly pays to know which column your income might fall into.
With that being said, here are eight sources of income that Social Security’s payroll tax won’t be able to touch.
1. Exempt wage income
One of the more controversial aspects of the payroll tax is that it’s only applicable to wage and salary income between $0.01 and $132,900, as of 2019, with this earnings cap rising to $137,700 in 2020. Every earned dollar above this cap is exempt from the 12.4% payroll tax. What this means is that while roughly 94% of working Americans are paying into Social Security on every dollar they earn, about 6% of the work force earning more than $132,900 (in 2019) will have some of their wages or salary exempted from the tax.
If you’re curious why this cap exists in the first place, it has to do with the Social Security Administration also capping monthly benefits paid at full retirement age.
2. Dividend income
The stock market’s plain-as-day secret is that dividend stocks and the regular income they provide are the key to rapid long-term wealth creation. Dividend stocks have historically run circles around their non-dividend-paying peers, and payouts can be reinvested via a dividend reinvestment plan. But one added bonus you may not be aware of is that dividend income doesn’t fall into the “earned income” column. This means if you’re raking in substantial income from dividends, you won’t have to worry about being hit with Social Security’s payroll tax on these payouts.
3. CD interest income
Chances are that investor interest in certificates of deposit (CD) from banks has waned considerably this decade as yields have shrunk. Nevertheless, CDs provide some of the safest sources of income in the country, albeit with those aforementioned low yields. The good news here is that the interest income earned on CDs is exempt from Social Security’s payroll tax. Note, however, that you could still owe tax at the federal or state level on the CD interest income you earn.
