Better for Employees? – A Brief Primer on Social Security

By Ray and Paul

Published March 2020

A recent stagehand discussion on Facebook inspired this piece. In a discussion about Social Security:

[Redacted] this is SO important! From what I understand your SS payout is based on the ten years before you stop working. They take your best year, out of those ten, and that determines what you can get. So you just need one year where you made a lot of money as an employee, to put yourself in a better bracket. Someone correct me if this is wrong, but this is what I was taught.

Put bluntly: this is completely wrong, as we’ll see below. One of the responses to this comment was:

[Redacted] I think she's saying that it is better to be an employee with taxes taken out of your checks, than an independent contractor. Employees can almost always get social security if they've worked long enough. It's harder for independent contractors (especially for ICs who don't even make enough money to have to file taxes).

Is there truth to this? Let’s look at how Social Security works. First, we’re going to concentrate on social security retirement benefits for the sake of simplicity. Disability benefits, survivors’ benefits, and spousal benefits are other facets of the social security program; more information on all benefits can be found at their website.

To qualify for Social Security retirement benefits, most people obtain 40 ‘credits’. In 2020, a person would earn 1 credit for each $1410 earned, up to a maximum of four credits per year. Those who are self-employed have an optional method of reporting earnings (explanation here), but its use is limited for non-farm income.

Social Security taxes are applied to the first $137,700 earned in a year by an individual. Employees do have a social security tax applied to their paychecks, so they will be paying into social security. It is true that independent contractors usually have a lower threshold to start paying income tax as compared to employees. However, independent contractors can have years where they do not make a profit, and thus pay no taxes on their negative earnings.

Let’s briefly examine what information Social Security uses to determine retirement benefits for a person. Your SS payout is based on your 35 highest earning years over your entire tax-paying history, not your ten highest, or last ten, or highest of your last 10. If you worked less than 35 years, then the quantity of years not worked are shown as having earned zero dollars. Based on these 35 highest earning years, an average earning per year can be determined.  There’s then a formula used to come up with the monthly retirement benefits, which you can read about directly from the Social Security Administration here.

These formulas do not change depending on how the individual is classified. The only differences are how much in taxes are being paid (because self-employed people pay both the employee’s and employer’s shares) and any potential differences in income.

The way the Social Security system is set up, if you’re an independent contractor making the same amount of annual income as an employee, you should be contributing the same amount to SS and Medicare, under the name of ‘self-employment tax’ at 15.3% (12.4% Social Security tax plus 2.9% Medicare tax), whereas an employee would pay only half of that rate – the employer would pay the other half.

If you’re paid at the same rate as an independent contractor as you would be if you were an employee, then yes, you’re better off financially as an employee – by that 7.65% which the employer would be paying. However, that’s just one of several reasons why independent contractors should be paid at a higher rate than employees. It’s not only SS (and Medicare) taxes. Independent contractors must take responsibility for all the expenses that a business covers – from liability insurance, to having their own tools and safety equipment, to taxes. Those same people also don’t receive benefits as part of their compensation – they can pay for generally equivalent services, but it’s another cost against any profit / earnings.

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