JCT Outlines Revenue Sources for Social Security Trust Funds

BACKGROUND ON REVENUE SOURCES FOR THE SOCIAL SECURITY TRUST FUNDS

Scheduled for a Public Hearing
Before the
HOUSE COMMITTEE ON WAYS AND MEANS
On July 25, 2019

Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION

July 24, 2019
JCX-11-19

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CONTENTS

INTRODUCTION

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INTRODUCTION

The House Committee on Ways and Means has scheduled a hearing on July 25, 2019, on H.R. 860 (116^th Congress), the “Social Security 2100 Act.”¹

The Federal government administers a number of social insurance programs (e.g. unemployment insurance, Social Security, Medicare) to provide benefits when certain insured events occur. Unlike welfare or public assistance programs, benefits under these programs are not based upon the income or assets of the recipient and are generally available to individuals who have made, or whose employers have made, contributions to the program through appropriate taxes. The Social Security, or the Old-Age, Survivors, and Disability Insurance (“OASDI”) program, is one of the largest social insurance programs, with 176 million individuals and their employers paying into the system, and 63 million beneficiaries receiving monthly cash benefits totaling $988 billion in 2018.²

Social Security funding is accounted for in the Old-Age and Survivors Insurance (“OASI”) Trust Fund and the Disability Insurance (“DI”) Trust Fund (together, the “OASDI Trust Funds,” also commonly referred to as the “Social Security Trust Funds”). Social Security benefits and certain Medicare benefits are financed primarily by payroll taxes on covered wages. Payroll taxes include taxes under the Federal Insurance Contributions Act (“FICA”) and the Self Employment Contributions Act (“SECA”). In addition, Social Security is partially financed by Federal income taxes paid by some beneficiaries attributable to their Social Security benefits and by interest income on Treasury securities held by the OASDI Trust Funds.³ Benefits are payable to retired or disabled workers and their family members and to family members of deceased workers when certain requirements are met, such as a minimum of ten years of covered employment in order to receive retirement benefits.

This document provides an overview of the major sources of revenue for the OASDI Trust Funds, a description of the revenue provisions of H.R. 860, the “Social Security 2100 Act,” and data and projections relating to the OASDI Trust Funds and proposed changes to revenue sources.

I. DESCRIPTION OF PRESENT LAW REVENUE SOURCES

A. Federal Insurance Contributions Act

In general

FICA imposes a tax on employers and employees based on the amount of wages paid to each employee during the year.⁴ The tax imposed is comprised of two components: OASDI tax and HI tax (health insurance tax, also commonly referred to as “Medicare tax”). The OASDI and HI taxes are generally collected as a single tax with portions allocated by statute among separate trust funds: the OASDI Trust Funds, and Medicare's Hospital Insurance Trust Fund and Supplementary Medical Insurance Trust Fund.⁵

Under the OASDI component, the rate of tax is 12.4 percent, half of which (6.2 percent) is imposed on the employer and the other half of which is imposed on the employee.⁶ The tax is imposed on covered wages up to the Social Security wage base ($132,900 in 2019). Generally, the Social Security wage base increases based on increases in the national average wage index.⁷

Under the basic HI component, the rate is 2.9 percent, also split equally (1.45 percent each) between the employer and the employee. The amount of wages subject to the basic HI component of the tax is not limited by the amount of the Social Security wage base. An additional HI tax applies to certain high-income individuals and is described below.

The employee portion of FICA taxes usually must be withheld and remitted to the Federal government by the employer.⁸ The employer is liable for the amount of this tax whether or not the employer withholds the amount from the employee's wages.⁹ In the event that the employer fails to withhold FICA tax from an employee's wages, the employee generally is not liable for the amount of the tax. If, however, the employer pays its liability for the amount of the tax not withheld, the employer has a right to collect that amount from the employee. If the employer withholds and pays the tax, the employer is indemnified against claims and demands of any person for the amount of any payment of the tax.¹⁰

Additional tax on high income individuals

The employee portion of the HI tax is increased by an additional tax of 0.9 percent on wages received in excess of $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, or $200,000 in any other case.¹¹

The employer is required to withhold the additional HI tax on wages and is liable for the tax if it is not withheld from wages. However, in determining the employer's requirement to withhold and its liability for the tax, only wages that the employee receives from the employer in excess of $200,000 for a year are taken into account and the employer must disregard the amount of wages received by the employee's spouse. Thus, the employer is only required to withhold on wages in excess of $200,000 for the year, even though the tax may apply to a portion of the employee's wages at or below $200,000 (for example, if the employee's spouse also has wages for the year, they are filing a joint return, and their total combined wages for the year exceed $250,000). The employee is liable for the additional tax to the extent that it is not withheld by the employer.

Social Security and Medicare benefits

The OASDI program under the Social Security Act provides for the payment of Social Security benefits to individuals based on wages earned as an employee and credited to the employee's earnings record.¹² Eligibility for Medicare coverage under the Social Security Act generally is based on eligibility for Social Security benefits and, thus, on wages credited to an employee's earnings record.¹³ The definitions of wages and employment for purposes of Social Security and Medicare eligibility are similar to these definitions for FICA tax purposes described below.¹⁴

Definition of wages and exemptions

Generally, the term “wages” for purposes of FICA taxation means all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.¹⁵ FICA applies to wages paid to an employee by an employer during the year. Wages include salaries, vacation allowances, bonuses, deferred compensation, commissions, and fringe benefits. Amounts an employer pays as a bonus for signing or ratifying a contract in connection with the establishment of an employer-employee relationship and an amount paid to an employee for cancellation of an employment contract and relinquishment of contract rights are also wages subject to FICA.

Numerous exceptions to the definition of wages that are subject to FICA exist. Several of the most prevalent exceptions are discussed below.

Retirement and pension plans

Employer contributions to a qualified retirement or pension plan are excluded from wages for purposes of withholding and employment taxes. This includes employer nonelective and matching contributions to 401(k) plans, and employer contributions to individual retirement accounts under a simplified employee pension (“SEP”) plan. Distributions from qualified retirement and pension plans and section 403(b) annuities are also exempt from FICA.¹⁶

Accident and health benefits

Employer contributions towards accident and health insurance for employees, their spouses, and dependents, are not considered wages and are not subject to FICA. Generally, this exclusion also applies for qualified long-term care insurance.

Generally, medical care reimbursements paid by an employer for an employee under an employer's self-insured medical reimbursement plan are not wages and thus are not subject to FICA.¹⁷

Cafeteria plans

A section 125 cafeteria plan is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits which are excludable from wages (and thus not subject to FICA). Cafeteria plans may include adoption assistance, dependent care assistance, group-term life insurance coverage, flexible spending arrangements, and health savings accounts among other qualified benefits.

Fringe benefits

Certain fringe benefits are excluded from gross income if certain conditions are met.¹⁸ There is a parallel exclusion from FICA if, at the time the benefit is provided, it is reasonable for the employer to believe that the benefit is excludable from gross income. Examples of nontaxable fringe benefits include no additional cost services, qualified employee discounts, working condition fringe benefits,¹⁹ minimal value (de minimis) fringe benefits,²⁰ qualified transportation fringe benefits, on-premises athletic facilities, and qualified tuition reduction by educational institutions.

Other special rules

In addition to specific examples discussed above, there are special rules for various types of services and payments that may exclude such services and payments from FICA. These special rules encompass, among others, the following circumstances: (1) payments to general or limited partners of a partnership; (2) certain supplemental unemployment compensation plan benefits; (3) tips if the combined total is less than $20 in a month; (4) worker's compensation; (5) domestic services provided in private homes if payments of less than $2,100 (in 2019) were made during the calendar year or if performed by an individual under age 18 and whose principal occupation is not as a household employee; (6) certain income derived from Indian fishing rights; (7) remuneration received from the exercise of certain statutory stock options; and (8) certain outplacement services provided to employees to help them find new employment (e.g., career counseling, resume assistance, and skills assessment).

Definition of employment and exemptions

For purposes of FICA, the term “employment” generally means any service performed by an employee for an employer if the service is either performed within the United States, performed in connection with an American vessel or aircraft, performed outside the United States by an American citizen or resident for an American employer, or covered under an agreement governed by section 233 of the Social Security Act.²¹

Certain types of employment are specifically excluded from FICA coverage.²² Common exceptions are described below.

Foreign agricultural employees

Services performed by certain foreign agricultural workers lawfully admitted to the United States for the purpose of performing agricultural labor on a temporary basis are not considered employment for purposes of FICA. Agricultural labor includes, among other services, cultivating the soil and raising livestock, and the operation, management, and maintenance of farm tools and equipment.²³

Student employees

Services performed in the employ of a school, college, or university (or an auxiliary nonprofit organization operated and controlled by a school, college, or university) are exempt from FICA if the services are performed by a student who is regularly attending classes at such educational institution.²⁴

Excepted student employment includes domestic services performed for a local college club or local chapter of a college fraternity or sorority by a student who is enrolled in and regularly attending classes at an educational institution. Student employees of Federal hospitals, other than medical and dental interns, are excepted from FICA, as are student nurses performing part-time services in a hospital for nominal earnings and as an incidental part of their training.

Government employees

While FICA generally applies to employees of the United States or any of its instrumentalities for services performed after 1983, and to employees of State and local governments, or instrumentalities that are wholly owned by one or more State or political subdivisions (other than employees of the District of Columbia, Guam, and American Samoa) for services performed after July 1, 1991, various exceptions apply. For example, services performed by inmates of a Federal penitentiary, by student nurses and student employees (other than medical or dental interns or residents) for a Federal hospital, and by individuals serving on a temporary basis as a result of fire, storm, earthquake, or similar emergency, are exempt from FICA. An exception also applies for certain individuals who participate in a retirement program maintained by a State or local government, and whose benefits under that plan are comparable to the benefits they would have received under Social Security,²⁵ although such employees are still subject to the HI tax if their employment began (or restarted) after March 31, 1986.

Employees of foreign governments

Services performed by an employee of a foreign government (and, in some cases, foreign instrumentalities) are generally exempt from FICA, regardless of whether the foreign government grants similar exemptions with respect to services performed in the foreign country by a U.S. citizen.²⁶ This exception applies to ambassadors, ministers, diplomatic officers and employees, consular officers, and non-diplomatic representatives.

Employees of international organizations

Services performed by an individual employed by an international organization are generally exempt from FICA.²⁷ Special rules apply, however, to Federal employees who are temporarily transferred to an international organization after 1994.²⁸ International organizations are public organizations entitled to the privileges, exemptions, and immunities available to international organizations under the International Organization Immunities Act.²⁹ Examples of international organizations include the United Nations, the World Health Organization, and the World Bank.

Railroad employees

Services performed by an employee or employee representative whose compensation is subject to the Railroad Retirement Tax Act³⁰ are exempt from FICA.³¹

B. Self Employment Contributions Act

In general

Generally, tax under SECA is imposed on the self-employment income of an individual. SECA tax has two components. Under the OASDI tax component, the rate of tax is 12.4 percent on self-employment income up to the Social Security wage base ($132,900 for 2019).³² Under the basic HI tax component, the rate is 2.9 percent of all self-employment income (without regard to the Social Security wage base).³³ As is the case with employees, an additional HI tax applies to the HI portion of SECA tax on self-employment income in excess of the threshold amount. Thus, an additional tax of 0.9 percent is imposed on every self-employed individual on self-employment income in excess of the same threshold amount as described above for the additional HI tax.³⁴

Self-employment income subject to the SECA tax is determined as the net earnings from self-employment.

Net earnings from self employment

Net earnings from self-employment is the gross income derived by an individual from any trade or business less allowed deductions which are attributable to the trade or business and allowed under the SECA rules. Certain passive income and related deductions are not taken into account in determining net earnings from self-employment, including rentals from real estate unless received in the course of a trade or business as a real estate dealer,³⁵ dividends and interest unless such dividends and interest are received in the course of a trade or business as a dealer in stocks or securities,³⁶ and sales or exchanges of capital assets and certain other property unless the property is stock in trade which would properly be included in inventory or held primarily for sale to customers in the ordinary course of the trade or business.³⁷

For purposes of computing net earnings from self-employment, taxpayers are permitted a deduction equal to the product of the taxpayer's net self-employment income (determined without regard to this deduction) and one-half of the sum of the rates for OASDI and HI, i.e., 7.65 percent of net earnings.³⁸ This deduction is determined without regard to the additional 0.9 percent HI tax that may apply to an individual. This deduction reflects the fact that the FICA rates apply to an employee's wages, which do not include FICA taxes paid by the employer, whereas the self-employed individual's net earnings are economically equivalent to an employee's wages plus the employer share of FICA taxes.³⁹ This is generally referred to as the “regular method” of determining net earnings from self-employment, and in Internal Revenue Service forms and publications is expressed as multiplying total net earnings from self-employment by 92.35 percent.

 

C. Income Taxation of Social Security Benefits

In general

Section 86 provides rules for determining what amount, if any, of a taxpayer's Social Security benefits are includible in gross income for purposes of the income tax. Social Security benefits that are not taxed under section 86 are excluded from gross income. For purposes of section 86, Social Security benefits generally include monthly retirement benefits payable under Title II of the Social Security Act and tier 1 Railroad Retirement benefits. If a taxpayer's Social Security benefits or Railroad Retirement benefits are offset by worker's compensation benefits, then the amount of the taxpayer's Social Security benefits for purposes of section 86 is increased by the amount of such offset.

The amount of Social Security benefits includible in gross income is determined under a two-tier system, under which provisional income is compared to threshold amounts. The first-tier threshold is $25,000 in the case of unmarried individuals and $32,000 in the case of married individuals filing joint returns.⁴⁰ The second-tier threshold is $34,000 in the case of unmarried individuals and $44,000 in the case of married individuals filing joint returns.⁴¹ These thresholds are not indexed for inflation.

For purposes of these computations, a taxpayer's provisional income is defined as adjusted gross income increased by certain amounts, generally including: (1) tax-exempt interest; (2) excludable interest on educational savings bonds; (3) adoption assistance payments; (4) certain deductible student loan interest; (5) certain excludable foreign-source earned income; (6) certain U.S. possession income; and (7) one-half of the taxpayer's Social Security benefits.

Taxpayers receiving Social Security benefits are not required to include any portion of such benefits in gross income if their provisional income does not exceed the first-tier threshold.

If the taxpayer's provisional income exceeds the first-tier threshold but does not exceed the second-tier threshold, then the amount required to be included in gross income is the lesser of: (1) 50 percent of the taxpayer's Social Security benefits, or (2) 50 percent of the excess of the taxpayer's provisional income over the first-tier threshold.

If the amount of provisional income exceeds the second-tier threshold, then the amount required to be included in gross income is the lesser of: (1) 85 percent of the taxpayer's Social Security benefits; or (2) the sum of (a) 85 percent of the excess of the taxpayer's provisional income over the second-tier threshold, plus (b) the lesser of (i) the amount of benefits that would have been included in income under the first-tier threshold inclusion rule (described in the previous paragraph), or (ii) $4,500 in the case of unmarried individuals or $6,000 in the case of married individuals filing joint returns.⁴² Tables 1 and 2 below summarize the income taxation of Social Security benefits.

Table 1. — Summary of the Taxation of Social Security Benefits
for Unmarried Taxpayers

Provisional income level	Amount included in gross income
$24,999 and below	0%
$25,000 to 33,999	First-tier inclusion is the lesser of . . .
	(1) 50% of Social Security benefit		(2) 50% of provisional income exceeding $25,000
$34,000 and above	Second-tier inclusion is the lesser of . . .
	(1) 85% of Social Security benefit	(2) 85% of the amount of provisional income exceeding $34,000 plus the lesser of . . .
		(2a) $4,500		(2b) amount of Social Security benefit that would have been included if the 50% rule applied

Table 2. — Summary of the Taxation of Social Security Benefits for Married Taxpayers Filing Jointly

Provisional income level	Amount included in gross income
$31,999 and below	0%
$32,000 to 43,999	First-tier inclusion is the lesser of . . .
	(1) 50% of Social Security benefit	(2) 50% of provisional income exceeding $25,000
$44,000 and above	Second-tier inclusion is the lesser of . . .
	(1) 85% of Social Security benefit	(2) 85% of the amount of provisional income exceeding $44,000 plus the lesser of . . .
		(2a) $6,000		(2b) amount of Social Security benefit that would have been included if the 50% rule applied

Special rules apply in some cases. In the case of nonresident individuals who are not U.S. citizens, 85 percent of Social Security benefits are includible in gross income and subject to the 30-percent withholding tax.⁴³ The taxation of Social Security benefits may also be specified in income tax treaties between the United States and other countries.

Trust funds

Revenues from the income taxation of Social Security benefits attributable to the second-tier (85-percent level) tax are credited quarterly to the Medicare Hospital Insurance Trust Fund.⁴⁴ The remainder of the proceeds from the income taxation of Social Security benefits are credited quarterly to the OASDI Trust Funds.⁴⁵

D. Interest

In general

Generally, interest income received by the OASDI Trust Funds arises from investments of the OASDI Trust Funds' balances.⁴⁶ The Secretary of the Treasury is required to invest the balance of the OASDI Trust Funds, less amounts necessary to meet current withdrawals, in interest-bearing securities backed by the U.S. government.⁴⁷ The securities currently held by the OASDI Trust Funds are two types of special issue securities only available to the Federal government trust funds that are backed by the full faith and credit of the U.S. government and redeemable at par: shorter-term certificates of indebtedness and longer-term bonds. As of December 31, 2018, the maturity dates of these securities range from 2019 to 2033, while interest rates range from 1.375 to 5.125 percent.⁴⁸

II. DESCRIPTION OF REVENUE PROPOSALS OF H.R. 860, THE “SOCIAL SECURITY 2100 ACT”⁴⁹

In general

H.R. 860 includes various proposals to increase Social Security benefits and the revenue sources of the OASDI Trust Funds. The revenue provisions are described below.

Revenue provisions

Section 104 of H.R. 860 changes the amount of Social Security benefits that are included in gross income for individual income tax purposes. The proposal replaces the present-law two-tier system of provisional thresholds with a single set of thresholds of $100,000 for joint filers and $50,000 for most other filers, and provides that as much as 85 percent of the benefits may be taxable. As is the case under present law, the proposed threshold amounts are not indexed for inflation. These changes under the proposal apply for taxable years beginning after December 31, 2019. Tables 3 and 4 below summarize the income taxation of Social Security benefits under the proposal.

Table 3. — Summary of the Proposed Taxation of Social Security Benefits for Unmarried Taxpayers

Provisional income level	Amount included in gross income
$49,999 and below	0%
$50,000 and above	Inclusion is the lesser of . . .
	(1) 85% of Social Security benefit	(2) 50% of provisional income exceeding $50,000

Table 4. — Summary of the Proposed Taxation of Social Security Benefits for Married Taxpayers Filing Jointly

Provisional income level	Amount included in gross income
$99,999 and below	0%
$100,000 and above	Inclusion is the lesser of . . .
	(1) 85% of Social Security benefit	(2) 50% of provisional income exceeding $100,000

Section 201 of H.R. 860 changes the earnings base for the OASDI portion of FICA taxes and SECA taxes. Under the proposal, in addition to wages and net income from self-employment below the Social Security wage base, OASDI taxes apply to annual individual wages and net earnings from self-employment in excess of $400,000. Since under present law the Social Security wage base is expected to increase based on changes in the national average wage index, but the $400,000 threshold under the proposal remains the same, over time the gap between the two is expected to shrink. This proposal applies to wages or remuneration paid, and net earnings from self-employment derived, in calendar years after 2019.

Section 203 of H.R. 860 increases the total OASDI tax rate by 0.1 percentage point annually, beginning in calendar year 2020 and through calendar year 2043, after which the rate remains at the increased level. Thus, the employer and employee rates of 6.2 percent each increase annually by 0.05 percentage point after 2019 to reach 6.7 percent in 2029, and reach a cap of 7.4 percent to apply for calendar years after 2042; and the SECA rate increases from 12.4 percent in 2019 to 13.4 percent in 2029, and reaches a cap of 14.8 percent to apply for calendar years after 2042. This proposal applies to remuneration received, and taxable years beginning, after December 31, 2019.

III. DATA AND PROJECTIONS

A. The OASDI Trust Funds

Table 5 summarizes the income for the combined OASDI Trust Funds in the year 2018. In 2018, 88.2 percent of total income was from net payroll tax contributions. Net payroll tax contributions consist of taxes paid by employees and employers on wages, and by the self-employed on self-employment income, covered by Social Security.⁵⁰ Interest earned on the OASDI Trust Funds' asset reserves accounts for 8.8 percent of total income, and the tax on Social Security benefits accounts for 3.5 percent of total income. The remainder of total income, less than 0.01 percent, is attributable to reimbursements from the General Fund of the Treasury.

Table 5. ─ Summary of 2018 Income of OASDI Trust Funds
[In billions]

Total Income in 2018	$1,003.4
Net Payroll Tax Contributions	$885.1
Interest	$83.3
Taxation of Benefits.	$35.0
Reimbursement from General Fund of the Treasury	[1]
[1] Less than $50 million. Note: Totals do not necessarily equal the sums of rounded components. Source: Social Security Administration.

Figure 1 shows the estimated asset reserves at the end of each calendar year of the OASDI Trust Funds' operations, in current dollars, from 1970 to 2034. For the asset reserves, benefit payments which were scheduled to be paid on January 3^rd for some past and future years were actually paid on December 31^st, as required by the statutory provision for early delivery of benefit payments when the normal payment delivery date is Saturday, Sunday, or a legal public holiday. For comparability with the values of historical years and the projections in this report, all OASDI Trust Funds' operations and asset reserves reflect the 12 months of benefits scheduled for payment each year.

The asset reserves have generally increased annually from 1970 ($38.1 billion) to 2019 ($2,895.9 billion), except for the 1976 to 1981 period, when they declined. However, estimates of the OASDI Trust Funds' operations indicate that the asset reserves are projected to decrease in all years after 2019 and to deplete by the year 2034. During this period, OASI and DI program costs are projected to grow, while interest earned on the OASDI Trust Funds' asset reserves are expected to decline.⁵¹ For example, in 2018 the asset reserves at the end of the year were $2,894.9 billion and costs were $1,000.2 billion. By 2034, asset reserves and costs are projected to be $246.6 billion and $2,419.9 billion, respectively, so estimates for later years are not shown.

B. The Social Security Wage Base and Rates

Table 6 displays the Social Security wage base and the contribution rate for employers and employees, and for the self-employed, from 1975 to 2019. The Social Security wage base grew from $14,100 in 1975 to $132,900 in 2019. For employers and employees, and for the self-employed, the contribution rate is categorized by the total tax amount, the OASDI tax, and the HI tax. For employers and employees, the contribution rate for the OASDI tax equals 6.2 percent of wages up to the Social Security wage base and for the HI tax equals 1.45 percent of wages with no wage cap in all the years after 1990, with the exception of the years 2011 and 2012. Similarly, for the self-employed, the contribution rate for the OASDI tax equals 12.4 percent of self-employment income up to the Social Security wage base and for the HI tax equals 2.9 percent of self-employment income with no wage cap in all the years after 1990, with the exception of the years 2011 and 2012.