Have you ever taken a look at your paycheck stub and seen all the deductions and withholdings on there? Perhaps you saw a line item for the FICA tax being withheld from your check. Maybe you are not even sure what that is and why it was taken out of your pay. We are here to help explain what the FICA tax is, how much it will cost you, and what it is used for. By the end of this article, you will have a much better understanding of this tax and understand why it is beneficial for you and your future. Keep reading to dive in!
What Is The FICA Tax?
Maybe you have stared at your pay stub in the past wondering, “What is FICA, and why are they taking money from me?” FICA, or the Federal Insurance Contributions Act, tax is a tax collected by the Federal government to fund the Social Security and Medicare programs. You might also hear this tax referred to as the Medicare tax, and the OASDI tax referred to as the Social Security tax. Technically, both Medicare and Social Security fall under the FICA category. FICA tax was established in 1935, the same year that Social Security was created. The tax was intended to provide retirement benefits and health insurance benefits to retirees who were no longer in the workforce.
The thought behind this tax was the fact that working Americans needed access to retirement benefits and health insurance after leaving the workforce. By paying into the system for years throughout their working lifetime, then they would be able to reap the benefits of these savings upon retirement. Social Security provides benefits to millions of Americans, and the FICA tax is the primary source of funding for the program.
Paying into the program through this tax also provides several other benefits. Not only can you get retirement benefits and hospital insurance, but if you have paid into the system long enough, then you will be eligible to receive Social Security Disability benefits in case you become disabled and are unable to work. You are entitled to life insurance benefits as well, and your minor children or spouse can receive these benefits if you die before receiving your Social Security benefits. These are known as survivor benefits.
These taxes are used to fund critical government programs, so paying the tax is mandatory. It will be automatically withheld from your check and remitted to the government by your employer. If you are self-employed you are not exempt from paying the tax. The bill will still be due when it is time to file your taxes, and you will be required to pay both the employee and employer portion of the tax bill.
Nearly every penny of the taxes that are collected are used by the Social Security Administration to fund benefit payments. Less than one penny from every dollar collected goes toward funding overhead and administrative costs. This money goes directly toward paying benefit recipients, and the program is fully funded for the next few years. However, in about 15 years, Social Security will only have enough money to fund about 86% of its obligations. So, at that time, either benefits or the tax itself may have to change.
After collection of the taxes, the funds are placed into the Social Security Trust Funds. These funds are maintained by trustees and used to make payments to all the recipients of Social Security and Medicare benefits. In addition to the taxes, these programs also rely on interest earned from these trust funds, monthly premium payments from some Medicare beneficiaries, and occasional government subsidies.
2021 FICA Tax Rates
Over the years, these tax rates have continued to increase since their inception. The original Social Security tax was less than 3% for the first couple of decades of its existence; however, it is more than double that today. Both the Social Security and Medicare taxes have more than doubled since their creation. However, thankfully, they have remained unchanged for the past couple of decades. That might have to change in the near future though as the Social Security program is quickly running out of money.
The tax withholding rates for FICA in 2021 are unchanged from 2020. You will pay 6.2% of your wage base, or gross income, in Social Security tax. In addition, you will pay 1.45% of your pay toward the Medicare tax. Not only are you required to pay these amounts, but your employer must pay the same percentages on your salary as well. So, overall, the FICA tax rate for 2021 is 15.3% of your gross salary. As previously stated, these taxes are automatically withheld from employee’s wages. If you are self-employed, unfortunately, you do not get an exemption. You will still pay these taxes when it comes time to file your Federal income tax return, and you’ll pay the full 15.3% – both the employee and employer portion.
The IRS does give you a little bit of a break if you are self-employed though. You will be allowed to deduct the employer portion of the self-employment tax that you pay from your personal income taxes. This will reduce the amount of tax that you owe whether you itemize deductions or take the standard deduction. Either way, it will help with your tax bill!
How To Calculate Your FICA Tax
The calculation of the tax is quite simple. It is calculated like most all other payroll taxes. Simply take your gross pay for the pay period and multiply that by the tax rate. In most situations, that is all you need to do. However, if your income is higher than the Social Security wage base, then your calculation will be a little different. Social Security has established a maximum wage for which Social Security taxes will be collected. For 2021, this amount is $142,800. So, for any income above this amount in the tax year, you will not be required to pay any taxes.
The Medicare tax, however, does not have an income limit. You will pay this 1.45% Medicare tax rate on each dollar that you earn regardless of what your annual income is. If you are self-employed, then you’ll pay the entire 2.9% tax on all your earnings. With the passage of the Affordable Care Act, the government can also collect an additional Medicare tax on wages earned above a certain threshold. The rate on this additional tax is 0.9%, and it helps to fund the program and pay for benefits associated with the rising cost of health care. Medicare is funded primarily from the Medicare tax, but it also receives funding from a few other sources. This is one reason the Medicare tax rate is lower than the Social Security tax rate. Many recipients of Medicare must pay a monthly premium, and these premium amounts help to fund the system as well. So, Medicare does not only rely on the taxes collected for their sole funding.
Calculating the amount of tax that you owe is much simpler than trying to figure out how much Social Security will pay you when it is time to apply for your benefits. The formula for that calculation is much more complicated, and it relies on using 30 years worth of your income history to arrive at your Average Indexed Monthly Earnings. You will then need to calculate your bend points and make any adjustments to your PIA. The easiest way to estimate your benefits is by simply creating a My Social Security account and using their online Benefit Estimator tool.
As we mentioned above, you are only required to pay Social Security taxes on your first $142,800 in income. One thing to watch carefully is the situation where you work two jobs and have a combined income over this number. Each employer will withhold the 6.2% Social Security tax even after you have surpassed the limit, as long as neither salary has surpassed the limit individually. You need to make sure that you get your refund of the amount you overpaid when tax season arrives. There is a place on your Federal tax return where you can show the amount of your overpayment and get it returned to you.
How Does FICA Work For Those Who Are Self-Employed?
We have already touched on this topic a little in the other sections, but here we will discuss how FICA works for those who are self-employed. For those who work for others, your employer automatically withholds this tax from your paycheck and remits it to the government. So, what happens when you are both the employee and employer? You get to pay both portions of the tax – the employee and employer’s share of the tax! Many small business owners find themselves in this situation each calendar year, and they are stuck with a higher tax payment than they might have anticipated. Luckily, the IRS does allow filers to deduct the employer portion of their taxes from their personal return.
Why Do I Have to Pay FICA?
FICA funds both Social Security and Medicare which are extremely important Federal programs. These programs provide benefits to people of old-age and with disabilities who can no longer work. The Social Security Disability insurance program is also funded by this tax, and it provides help to people who become disabled and are no longer able to work. Your taxes are by far the largest source of funding for all these programs, and they would be unable to operate without them. One day, you will likely find yourself ready to claim Social Security benefits of some type, and you will be glad that you have paid into the system and are eligible to receive them when the time comes. The way Social Security works is by having enough people pay into the system to fund those receiving benefits. If you do not pay into the system, then you are not allowed to reap the rewards of the system.
Your future Social Security benefits are affected by the FICA taxes that you pay today. When it comes time to apply for retirement benefits, your benefit amount will be calculated by looking at your 30 highest years of earnings. So, the higher your salary while you are working, the more you will pay into the system. This means that the benefits you receive at retirement will be higher as well.
Nobody enjoys paying taxes, but the FICA tax is an extremely important one for many reasons. Now, you should have a better understanding of what this tax is used for and how much you will have to pay. In most cases, you never even have to worry about it because your employer automatically withholds the tax and remits it for you. If you are self-employed, it becomes a little more trouble because you must remit the tax and pay both the employee and employer parts of the tax. Hopefully you will be a little more comfortable now when you see the FICA withholding from your pay.
Frequently Asked Questions
Is FICA the same as Social Security?
No, these two programs are not the same. FICA is the law that allows tax to be collected to fund Social Security. The Social Security tax is included as part of the FICA taxes. In addition, the Medicare tax is also part of FICA. While you will often hear these things referred to within the same sentence, it is important that you distinguish the difference between the two. Social Security is the program that provides retirement and disability benefits to people of old-age or who are no longer able to work, while FICA is the act which enables collection of the tax to fund the Social Security program.
Does everyone pay FICA tax?
Yes, for the most part everyone pays this tax. There are a few exceptions to this rule though. Children under age 18 who are employed by their parents are not required to pay the tax. Some state and local government salaries are exempt from the tax as are some wages of church employees. Salaries received by students performing services for a college, school, or university are not subject to the tax, and qualified retirement plan contributions by an employer will not be taxed. If you are part of a state-funded pension or retirement plan, then are likely exempt from the 6.2% Social Security portion of the tax. You would then only be required to pay the 1.45% Medicare portion of the tax.
What determines how much my employer has set aside for FICA and other tax withholding?
For FICA, the withholding is basically always the same. It is simply a percentage of your gross earnings. However, other tax withholdings are based on your personal situation and the allocations you selected on your Form W-4. The elections on your W-4 like filing status and number of dependents can have a big impact on your withholdings for Federal and state taxes. However, these elections do not have much bearing on your FICA withholding. This withholding will simply be 7.65% of your gross pay each pay period.
Many people might think that their tax bracket has an impact on their FICA withholding; however, it does not. Your tax bracket really only affects your federal, state, and local tax withholdings. Your tax bracket does have an effect on whether you are required to pay the additional Medicare tax. If you are a single filer and make more than $200,000 or joint filers earning more than $250,000, then you will pay an extra 0.9% of your earnings toward Medicare.
What does FICA stand for?
FICA stands for the Federal Insurance Contribution Act. This act was signed into law in 1935 and established a means by which the Federal government could collect taxes to fund the Social Security and Medicare programs. FICA was enacted as the tax provision of the Social Security Act which established the Social Security program itself. Some people think that FICA and Social Security are the same thing. They are not the same thing, but they are closely related. FICA allows for the collection of the tax that funds Social Security and Medicare.
What is the FICA tax rate on self-employment income?
The tax rates are the same on self-employment income as they are on regular income. The difference is that self-employed individuals must pay both the employer and employee portions of the tax. In effect, this doubles the amount of tax that these individuals must pay. So, instead of simply paying the 7.65% that is required of all employees, they effectively must pay 15.3% on their earnings. They are provided with a slight tax break because they can deduct the employer tax from their personal income tax filings. The IRS did this as a way to help put these individuals in the same position as other companies and employers.
How does FICA work for those who pay into the system as a contractor?
Businesses do not withhold any taxes when they pay independent contractors. Instead, these contractors are treated as self-employed individuals for tax purposes. They will pay the self-employment tax. Basically, this means that they will pay both the employer and employee portion of the tax. Instead of only paying 6.2% for Social Security and 1.45% for Medicare, they will pay the full 15.3% that is owed to the government. Independent contractors typically pay their taxes on a quarterly basis instead of annually, but that is another topic that we will not cover here.