The major source of income to the Social Security Trust Funds is employment taxes, specifically taxes on wages as defined in the Federal Insurance Contributions Act (FICA) and taxes on self employment as defined in the Self Employment Contributions Act (SECA). The following describes how these Social Security taxes are transferred to the trust funds.
FICA taxes consist of an employee and an employer share (typically equal). Tax liability occurs when employers pay their employees, but actual deposits of the taxes are delayed, depending on amounts of FICA taxes and withheld Federal income taxes accumulated by the employer. Treasury regulations stipulate four deadlines by which employers must deposit the combined FICA and income taxes: 1) January 31 of the year following when the liability is incurred for very small businesses; 2) the middle of the month following when the liability is incurred for small businesses not eligible for the Form 944 filing deadline; 3) three banking days for medium-size businesses;   4) the next banking day for large businesses. Employers deposit these accumulated taxes in the general fund of the Treasury through electronic transfers to Federal Reserve banks.
Employers are not required to distinguish Federal income taxes from FICA taxes when they deposit these taxes. Therefore, the Social Security Act requires the Department of the Treasury to transfer FICA taxes due to the Social Security and Medicare trust funds initially on an estimated basis. The Act further requires the Social Security Administration (SSA) to certify the amount of wages subject to FICA tax based on employment records maintained by SSA. These certified wages are used to adjust the amounts previously transferred to the trust funds. By law, FICA taxes must be based on these certified wages, not on the actual amount of taxes collected by the Internal Revenue Service (IRS).
SECA taxes are treated similarly. Self-employed individuals are typically required to deposit estimated SECA and Federal income taxes for a calendar year on a quarterly basis, without distinguishing between the tax types. Any discrepancies between the estimated taxes deposited and the actual tax liability owed are made up when individuals file their Federal income tax returns for the year. Treasury transfers estimated SECA taxes initially, and adjustments are made based on self-employment income (SEI) amounts certified by SSA.
Estimates and transfers
Based on a Memorandum of Understanding between the two agencies, SSA provides Treasury with estimates of employment tax liabilities that will be deposited in the general fund of the Treasury in upcoming quarters. These estimates represent amounts of tax liability that will ultimately be due to the trust funds based on future certified earnings and will be deposited by employers and self-employed individuals during those quarters, taking into account the delays in depositing for employers and the pattern of estimated and final tax payments by self-employed individuals described above. Treasury splits the estimated quarterly tax collections into monthly amounts, and also splits the monthly amounts into estimated tax liability amounts.
Treasury also estimates Federal income taxes withheld by month and computes monthly ratios of FICA taxes, one for each trust fund, to the sum of FICA taxes and income taxes. Then Treasury multiplies each day's actual tax receipts by each ratio, yielding the estimated FICA portion, and transfers that portion into the appropriate trust fund. If the sum of such daily deposits reaches the month's estimated total before the end of the month, then no more taxes are transferred in that month. On the other hand, if the sum fails to reach the month's estimated total, then extra money is transferred on the last day of the month to make up the shortfall. Either way, the estimated amount for a month is the total amount transferred. The same method is used for SECA taxes.
For each month, Treasury estimates the portion of FICA taxes to be transferred that represent liability for wages paid in
- the current calendar quarter, and
- the previous calendar quarter (if any).
Annual tax liabilities are the appropriate sums of monthly liabilities and form the basis for subsequent FICA tax adjustments.
Similarly, Treasury estimates the portion of SECA taxes to be transferred that represent liability for self-employment income earned in
- the current calendar year, and
- the previous calendar year (if any).
Annual tax liabilities are the appropriate sums of monthly liabilities and form the basis for subsequent SECA tax adjustments.
In order to adjust previously transferred tax liabilities made on an estimated basis, and to reflect the latest available earnings data, SSA provides Treasury with a letter once each quarter that certifies changes in earnings (both wages and self-employment income) since the previous such letter. All past years’ earnings are subject to correction, back to 1937, the first year in which wages were taxed. Changes in earnings for a year can be positive or negative, depending on the net effect of any corrections. The corrections tend to be smaller for years that are further in the past.
SSA collects wage data from two main sources:
- Forms 941, processed by IRS, provide wage data by employer by calendar quarter. IRS sends the processed data to SSA four times per year.
- W-2s, processed by SSA, provide individuals' wage information by calendar year.
Based on a decision by the Comptroller General in 1995, SSA is permitted to consider both Form 941 and W-2 data when certifying wages. For each quarterly certification letter, SSA determines the amount of wages reported from all Form 941 data received to date for each calendar year by adding up the quarterly amounts from those forms. SSA also determines similar annual amounts from W-2s received to date. The certified amount for a year is the greater of the amount determined from Forms 941 and the amount determined from W-2s.
SSA’s main source of SEI data is data processed by IRS from Schedules SE (Form 1040).
Because of known delays in reporting, SSA makes estimates of earnings amounts for recent years. This prevents a negative bias in trust fund transfers that would occur if only reported data were used. These estimates are included in the certification letters used for the adjustments in June and December of each year, as described in the next section.
The certification letters for all four quarters contain changes in reported wages and SEI for years prior to those for which estimates are made.
Adjustment of estimated tax liability
FICA tax adjustments are made in March, June, September, and December of each year. For the quarters ending in June and December, adjustments are made on the basis of new estimates of liability for the most recent six calendar years using accumulated Form 941 and W-2 data and the historical pattern of earnings reporting delays. The initial adjustment for a particular year occurs in June of the following year. In addition, small adjustments are made in March, June, September, and December to reflect any small changes that are reported in the certification letters for years prior to the most recent six years.
SECA tax adjustments are done similarly, except that the quarterly adjustments are made on the basis of new estimates of liability for the second prior year and the six years prior to that. The initial adjustment for a particular year occurs in December of the second following year.
The calculation of tax adjustments is done independently by Treasury and SSA. When agreement is reached, Treasury takes the steps necessary to transfer the funds.