Millions Of Workers Will Pay More Taxes In 2017 Despite Not Having A Higher Tax Rate

Millions of taxpayers will see a tax increase in 2017: they just won't realize it immediately. That's because the tax increase won't be found with a bump in income tax brackets (more on tax brackets from Claudia Hill here) or a rate increase but a change in the cap on wages subject to Social Security taxes.

Here's how that works. Wages and self-employment income (but not investment and other unearned income) are subject to Social Security and Medicare taxes. Taken together, those taxes are known as FICA (Federal Insurance Contributions Act) taxes or payroll taxes since for employed workers, those taxes get taken right out of your paycheck. Sometimes, taxes on self-employment income are separately referred to as SECA (Self-Employment Contributions Act) taxes since self-employed persons pay both the employee and employer contributions.

All wages are subject to Medicare taxes. If you're employed, you pay Medicare tax (1.45%) as the employee, and your employer kicks in tax at the same rate (1.45%) on your total wages; if you're self-employed, you pay both portions.

(As of 2014, high-income taxpayers are also subject to a Medicare surtax (.9%) tacked on to wages which exceed $200,000, or $250,000 for married taxpayers.)

If you're employed, you pay Social Security tax (6.2%) as the employee, and your employer also pays the same rate of tax (6.2%); again, if you're self-employed, you pay both portions. After decades of changes, the 6.2% rate has more or less remained the same since 1990:

(*You may recall that, in 2010, there was a "payroll tax holiday" which gave employees a break on rates).

But here's where Social Security taxes differ significantly from Medicare taxes: Social Security taxes are subject to a wage cap. In other words, you pay Social Security taxes on your earnings until you hit a magic number. After that, your wages are no longer subject to Social Security taxes (they remain subject to Medicare taxes).

For 2016, that magic number was $118,500. That means that whether you made $1,000 or $100,000, you paid Social Security taxes on that income. But if you earned $118,501? You paid Social Security taxes on $118,500, but not on the extra dollar. And if you earned $1,118,500? You paid Social Security taxes on $118,500 but not on the extra million.

The wage cap is generally adjusted from year to year to account for a change in wages. And this year, even if it doesn't feel like it, wages are on their way up. The result? Earnings subject to the Social Security tax are capped at $127,200 in 2017: that's a 7.3% increase from 2016. And 2015 (as it turns out, there was no increase from 2015 to 2016). If that increase feels high, it is: the boost is the largest, by percentage, since 1981.

Here's what the wage cap has looked like since 2000:

So what does the increase mean in terms of real dollars? For taxpayers, it boils down to a couple of numbers:

1. Workers who were already safely over the cap - those making $128,000 or more - will see less money in their pockets. If you were making $130,000 in 2016 and 2016, you'll pay an additional $539.40 in taxes in 2017: that's 6.2% of $8,700, or the difference between $127,200 and $118,500 (remember you won't pay any Social Security taxes on wages which exceed $127,200).
2. Workers who were just over the cap in 2015 and 2016 but under the 2017 cap - for example, those making $120,000 - will pay a few hundred dollars, or 6.2% of the difference between their wages and the new cap, $127,200.

These changes are expected to affect 12 million workers in 2017. For the 161 million workers who are under the cap, there will be no change.

For more on 2017 taxes, including income tax rates, see this post. For what you need to know about the upcoming tax season - which begins on January 23 - see this post.