Most employers and employees are familiar with the payroll taxes they pay to fund Social Security and Medicare. These two taxes were established under the Federal Insurance Contributions Act, a federal law that requires virtually everyone to fund two of the most prevalent public benefits programs maintained by the federal government. The FICA tax is a shared tax burden for employers and employees, and even self-employed individuals have FICA tax obligations under most circumstances.
What is the FICA tax?
The Federal Insurance Contributions Act established tax rates required of both employers and employees to fund Social Security and Medicare. The small tax that comes out of each worker's paycheck is a portion of the FICA tax, with employers also contributing funds per employee.
"The Federal Insurance Contributions Act, or 'FICA,' is a federal tax that both employers and employees pay via their payroll tax obligations," James Maio, director of tax at Slate Law Group, told business.com "The FICA tax is made up of two separate taxes, the Social Security tax and the Medicare tax."
The FICA tax pays into federal retirement and disability benefits established under Social Security, as well as health insurance for American citizens age 65 and older under Medicare. [Read related article: Employer's Guide to Payroll Deductions]
How does the FICA tax work?
The FICA tax is based on a set rate that can change through legislative action. Currently, the total FICA tax finances Social Security through a 12.4% payroll tax on wages up to a taxable earnings cap of $137,700. That cap is set to increase to $142,800 on Jan. 1, 2021. Any earnings above the cap are not subject to the Social Security portion of the FICA tax.
Medicare is funded through a 2.9% payroll tax with no taxable earnings cap. This means the Medicare tax rate still applies even when earnings surpass the Social Security cap. However, Maio said there is an additional Medicare tax for employees who fall into the "highly compensated" category – those who earn $250,000 annually if married and filing jointly, those who earn $125,000 annually if married and filing separately, and those who earn $200,000 annually and file as single or head of household.
"The law requires employers to withhold the additional 0.9% of Medicare tax from the wages of employees earning [highly compensated salaries]," Maio said.
Otherwise, the total FICA tax costs are split evenly amongst employers and employees.
"FICA tax payments are split between an employer and the employee. Each pays an equal share of the taxes," said Ana-Maria Sanders, financial analyst at Open Cash Advance. "If you work a typical job where your employer gives you a W-2 by the end of the year, your employer will automatically deduct your share of the FICA taxes from your paycheck. It will send that share directly to the IRS for you."
Sanders added that employers pay their half of the tax directly to the IRS.
Self-employed individuals also have to pay the FICA tax. Since self-employed individuals are considered both employers and employees, they cannot split the FICA tax. Therefore, self-employed individuals typically pay a total FICA tax of 15.3%. This is often referred to as a self-employment tax, or SE tax for short.
"In the case of self-employed people, they must pay both the employer side and the employee side of the FICA tax," Sanders said.
The two components of the FICA tax directly contribute to the Social Security benefit that employees can draw from upon reaching retirement age, as well as disability benefits for workers who are unable to secure employment after sustaining injury or disability. The Social Security portion also covers payment to widows and their children in the event of a married worker's death. The Medicare portion of the FICA tax supports health insurance through Medicare for all Americans age 65 and older.
What is the current FICA tax rate?
The current FICA tax rate is 15.3%. It comprises these two taxes:
- Social Security: The current Social Security tax rate is 12.4%, which makes up the lion's share of the FICA tax rate.
- Medicare: The current Medicare tax rate provided for under FICA is 2.9%.
For employers and employees, this total tax rate is split evenly. As a result, 7.65% of each employee's annual taxable income is deducted to fund Social Security and Medicare. Additionally, each employer must pay 7.65% of annual payroll toward the FICA tax. Typically, this tax rate is broken down across each of an employee's paychecks, resulting in small deductions throughout the year to meet the annual obligation.
Again, self-employed individuals pay the entirety of the FICA tax, resulting in a 15.3% tax rate that must be paid when they submit their 1040 to the IRS by April 15.
Do I have to pay the FICA tax?
Most employers, employees and self-employed individuals must pay the FICA tax.
"All businesses and individuals who work and earn money from U.S. sources must pay FICA," Maio said. "Therefore, most people can't avoid paying Social Security and Medicare taxes on their employment and self-employment income. There are, however, exemptions available to specific groups of taxpayers. Reach out to a tax professional to not only see if you qualify for those exemptions but to also ensure that you adhere to all rules and regulations when filing."
Alexis Krystina, principal accountant and founder of Advance Accounting, said one of those exceptions is self-employed individuals who hire their dependents.
"The one exception that benefits many self-employed business owners is that children under 18 who are employees of their parent's business do not need to pay FICA," Krystina said. "So, a business owner can hire their child without having to withhold FICA taxes and without needing to pay their employer portion of 7.65%."
Additionally, Maio said, employees have the option to stop FICA tax deductions from their paychecks. However, this does not absolve employees from paying the FICA tax; they will simply be required to pay it in a lump sum on April 15.
"You can stop FICA deductions from your paycheck by informing the person or department responsible for payroll at your company that you want to terminate your FICA withholdings," Maio said. "This will stop the withholding of the FICA tax from your paycheck. However, by not having FICA withheld from your pay, come April 15, you will be looking at a hefty tax bill. Further, you will lose a big deduction by not having FICA taken out of your pay, and as a result, you will most likely end up owing a large amount of federal tax at tax time."
How to calculate your FICA tax obligation
To determine your FICA tax obligation as an employer, multiply your total payroll by 7.65%. Be sure to determine whether any exceptions apply, such as individuals making more than the Social Security earnings cap of $137,700.
Employees can calculate their total annual obligation in much the same way, by multiplying their annual salary by 7.65% minus any wages over the Social Security earnings cap. However, if they have any pretax deductions, like for a 401(k) retirement savings plan, they should subtract those from their gross pay before moving forward with the calculation.
Self-employed workers should calculate their annual taxable earnings and multiply the total by 15.3%, minus any deductions or exceptions they may qualify for. To determine whether any of these exceptions apply to you, consult a certified public accountant. Failure to meet your tax obligations under FICA could result in back taxes or legal action if left unaddressed, so be sure to fully discuss your requirements with your CPA.