FICA Tax Threshold, Social Security Benefits Will Moderately Increase

Highly-paid wage earners will see a moderate increase in the wage base on which Social Security taxes are due for 2005, while Social Security beneficiaries will see a moderate increase in their monthly checks due to cost-of-living adjustments.

The 2005 wage base of $90,000, is $2,100 higher than the 2004 amount, and the maximum additional Social Security tax that might be collected on someone earning above the 2004 wage base is $130.20. Meanwhile, as a result of inflation, an increase of 2.7 percent will be applied to this coming year's benefits, starting with December 2004 benefits, which are paid in January 2005.

FICA Taxes

The tax increase will show up in the amount of FICA (Federal Insurance Contribution Act) tax deducted next year from the paychecks of those earning above the 2004 wage base. Although the tax rate for the Old-Age, Survivors and Disability Insurance (OASDI) portion of FICA has held steady at 6.2 percent since 1990, the amount of wages subject to the tax can, and usually does, increase each year, based on a national wage index. The taxes paid by employees are matched by identical amounts paid by employers into the Social Security system.

The tax rate for the "Hospital Insurance," or Medicare, portion of FICA is 1.45 percent, and it applies to every dollar of earnings. This amount also is matched by employers.

Avram Sacks, J.D., Social Security analyst with CCH, noted that taxes for self-employed individuals use the same earnings base, but the rates are double those of employees, since the self-employed must also pay the "employer" portion of the taxes.

"This means that high-earning, self-employed individuals may owe as much as $260.40 in additional self-employment tax in 2005," Sacks said. "However, they can recoup some of this amount through a deduction on their federal income tax."

About 9.9 million workers will be affected by the higher wage base in 2005. The wage base for 2005 is $300 more than the highest estimated increase published in the 2004 Annual Report of the Board of Trustees of the Federal Old-Age, Survivors and Disability Insurance (OASDI) Trust Funds issued in March of this year. The 2005 wage base reflects national average wages for 2003, the variable upon which the 2005 wage base formula is based. The 2003 national average wage index of $34,064.95 is 2.44 percent higher than the 2002 national average wage index.

"This is more than the 1.98 percent increase predicted in even the most liberal scenario by the Social Security trustees in their March report," Sacks noted.

"The wage base also is a benefits base," Sacks noted. "Only earnings up to the wage base are considered in calculating Social Security benefits. As a result, those who pay more now should receive more later. Some private pensions also use the amount of 'covered compensation'--that is, compensation up to the wage base--in calculating their benefits as well."

For the second year in a row, there will be no increase in the amount of wages a domestic worker can earn without being subject to FICA taxes. In 2005, you can pay a domestic worker, such as a maid or nanny, up to $1,400 without having to wrestle with federal withholding on wages.

Social Security Benefits

The 2.7-percent cost-of-living adjustment (COLA) will produce an estimated monthly benefit of $955 for all retired workers in 2005, $33 a month more than in 2004. However, $11.60 of that increase will be eaten up by a rise in the premium paid by beneficiaries enrolled in Medicare Part B in 2005. With a total monthly Medicare Part B premium of $78.20 in 2005, Social Security beneficiaries enrolled in Medicare Part B will see that average $955 benefit reduced to $876 after rounding required by law.

A typical married couple, both receiving benefits, can expect to find $1,574 in their monthly benefit checks in 2005, $51 more than the comparable 2004 benefit, while the average widow or widower living alone will receive an average benefit of $920, an increase of $32. These amounts do not reflect deductions for Medicare premiums.

The maximum monthly benefit payable to an individual reaching full retirement age, which is age 65 and 6 months for those born in 1940, will be $1,939. This is $114 more per month than what was payable to someone retiring at the full retirement age of 65 and 4 months in January 2004 and $65 per month more than the maximum benefit of $1,874 payable to someone born in 1940 who still wishes to retire on reaching age 65 in 2005.

The Social Security COLA is applied to several types of benefits: retirement, disability, survivors--such as children and widow(er)s--and to the maximum family benefit, which is the maximum that can be paid if more than one family member is receiving benefits based on one wage earner's account.

The increase is largely driven by an increase in shelter and energy costs, which account for approximately 58 percent of the increase in the consumer price index over the past 12 months, according to Avram Sacks, J.D., CCH Social Security analyst.

"The magnitude of the increase was not expected by the Board of Trustees of the Federal Old-Age, Survivors and Disability Insurance (OASDI) Trust Fund last March," said Sacks. "At that time, they predicted a 1.1-percent increase, less than half the actual figure based on the rise of the Consumer Price Index for Urban Wage Earners and Clerical Workers from the third quarter of 2003 through the third quarter of 2004."

The amounts that certain Social Security beneficiaries can earn without having their benefits reduced--"Retirement Test Exempt Amounts" in Social Security terminology--also will go up next year.

Workers under full retirement age who are receiving benefits can earn up to $12,000 in 2005, or $1,000 per month, without having their benefits reduced. This is an increase of $360 annually over the 2004 limit.

A modified test applies to workers who reach the full retirement age of 65 and 6 months in 2005. In the months before they reach full retirement age, these individuals may earn up to $31,800 without having their benefits reduced. Once they reach full retirement age, benefits are no longer subject to any retirement test.

"This is an increase of $720 over the 2004 limit for these workers," Sacks noted.

An "earnings test" for beneficiaries at full retirement age through age 69 was abolished by legislation in 2000. Beneficiaries age 70 and older have not been subject to benefit reductions based on earnings since 1983.

The amount of monthly earnings in 2005 that will give rise to a presumption that a disability beneficiary is no longer disabled - that is, the amount that's deemed sufficient to demonstrate an ability to engage in "substantial gainful activity" is $830, an increase of $20 from 2004.

Disability beneficiaries may work for as many as nine months during any 60-month period without affecting their rights to receive benefits. This is known as "trial work." In 2005, a disabled beneficiary who works will not be treated as having engaged in trial work for any month in which his or her earnings are no more than $590, an increase of $10 over the 2004 limit.

Related items:

Congress Approves New Tax Cuts Geared Toward Businesses and Individuals

Congress Extends Individual and Business Tax Cuts; Adds New Tax Relief

Congress Moves To Make Some Tax Cuts Permanent

Prepare Now for Next Year's Tax Season

Posted September 27, 2004.