On the average U.S. employee paycheck, the recipient sees some common terms and figures, including the net amount of the check.
But if you look closer at your complete pay stub, past the "hours and earnings" section, you'll likely see a section called "taxes and deductions." Scroll down there, and you'll see (or should see) these four lines:
- Federal tax (and amount deducted)
- State tax (and amount deducted)
- Medicare, or "FICA" tax (and amount deducted)
- Social Security, or "FICA" tax (and amount deducted)
It's the last two lines that might leave you scratching your head the most, and lead you to wonder who is FICA and why is it snapping up 7.5% of your check every pay period.
There's a good reason for that, and it has to do with your Social Security and Medicare contributions to your retirement. Simply put, FICA is the engine that drives those deductions forward, and helps fund Social Security and Medicare - and that's why it's worth a closer look.
What Is the FICA Tax?
FICA is short for Federal Insurance Contributions Act, government legislation passed in 1935 to fund Social Security.
The FICA tax is the amount of money Uncle Sam deducts from your paycheck every time you're paid. The money goes to the Internal Revenue Service first, then is steered into a Social Security fund to pay for Social Security program funding. A portion of your FICA tax also goes into the federal government's Medicare trust fund. (Medicare didn't launch until 1965.)
The Federal Insurance Contributions Act was designed, in large part, to lay out the rules on how Uncle Sam would collect payroll taxes and steer them into the Social Security Fund.
According to the U.S. Social Security Administration, the original FICA legislation placed benefit provisions in Title II of the Act, while the taxing provisions were in a separate title, Title VIII. That led Congress to adjust FICA in 1939 and carve out the Title VIII taxing provisions by taking them out of the Social Security Act and placing them in the Internal Revenue Code.
Even bureaucrats in Congress knew better to call the new section, which would be on full public display on every paycheck, "Title VIII." Instead, Congress renamed the statute "Federal Insurance Contributions Act," or FICA, and that's the term workers see on their paychecks.
Is the FICA Tax Mandatory?
Make no mistake, FICA taxes are mandatory. Both employees and employers have to pay them. Not doing so will get the attention of the IRS, with the resulting scrutiny, tax penalties and other negative scenarios that brings to the table.
Most Americans do pay the FICA taxes but there are a few exceptions. For instance, civilian federal government employees on the job prior to 1984 don't pay Social Security taxes (but do pay Medicare taxes.) Additionally, select state workers on pension plans don't pay FICA taxes, and non-resident aliens and qualifying members of some religious groups don't pay FICA taxes, either.
Since the FICA tax combined both your Social Security and Medicare deduction, the money taken out is deemed a mandatory deduction by the U.S. government. The amount of money deducted for both Social Security and Medicare is bundled together as one amount - a figure the federal government calls payroll taxes, more formally known as FICA.
There's a caveat here and it's a big one.
Your Social Security/Medicare deduction doesn't go directly toward your own Social Security or Medicare fund - the program doesn't work like that. Instead, it goes into a general fund that pays for current retirees' Social Security and Medicare payments. Instead, you'll be counting on future generations of workers to fund your own Social Security payouts, a trend that's not working in the favor of today's workers, as more current retirees far outnumber current employees in the U.S. workforce.
FICA isn't just for retiree payouts, either. Payroll deductions can also go into government funds that pay for widows, widowers and children who lose a working parent, and thus qualify for that worker's Social Security benefits.
Similarly, workers who become disabled may also be able to receive Social Security payments.
How Is FICA Tax Calculated?
In general, the FICA pay-in formula works like this:
- The FICA tax represents 7.65% of payroll earnings, up to $127,000 (any income earned via wages above $127,000 aren't subject to FICA taxes.)
- Workers pay 6.2% of their paycheck toward Social Security.
- Employers pay 6.2%, per employee, for a combined amount of 12.4% of a career professional's income.
- Additionally, Uncle Sam deducts 1.45% from every worker's paycheck for Medicare, and that 1.45% number is matched by an employer contribution (for a total of 2.9%), thus fulfilling the FICA obligations of both employee and employer.
Do the math and you'll see that 12.4% plus 2.9% = 15.3% - the total FICA tax.
It's also worth noting that no maximum Social Security tax exists for companies paying FICA taxes, and there's no maximum Medicare tax for both workers and companies paying FICA taxes. In other words, Medicare taxes, via FICA, are levied on all income earned by a worker - they're not capped at $127,000.
Occasionally, a company may deduct too much money from an employee's paycheck for FICA tax purposes (usually, that happens when a business deducts more than the maximum Social Security amount needed to satisfy FICA obligations). When that scenario occurs, the company must refund the deducted cash directly back to the worker.
How Does the FICA Tax Work Into the Affordable Care Act?
With the passage of the Affordable Care Act on March 23, 2010, a new FICA tax emerged from the legislation.
With the ACA as the law of the land, employees who earned more than $200,000 annually were hit with an additional 0.9% Medicare surcharge tax. That tax is the responsibility of the employee and not the employer.
The result of the ACA Medicare surcharge tax was this:
- Employees who earned up to $127,000 annually owed 1.45% in FICA taxes.
- Employers owed $127,000 in FICA taxes on those employee wages.
- Employees who earned $200,000 or more annually owed not only the 1.45% FICA tax up to $200,000 in income, and an additional 0.9% on any workplace income above and beyond $200,000 in annual income.
How Does the FICA Tax Impact Self-Employed Workers?
There's another caveat here for self-employed workers, and it's not a good one - at least at first glance.
To meet their FICA obligations, self-employed individuals have to pay the entire freight - 15.3% - of their net income, reportable on IRS Schedule SE on their federal income tax.
Business owners and other self-employed career professionals do get a tax deduction to help pay for their FICA taxes. Specifically, self-employed workers can deduct 50% of their self-employment tax from their adjusted gross earnings on their tax returns.
There's also a school of thought among accountants that traditional full-time employees actually suffer when their employers are forced to pay their FICA taxes. In doing so, companies may be forced to keep salaries lower so they can pay their staffer's FICA taxes.
Summing It Up
Here's a thumbnail sketch of who owes what on FICA taxes:
- Social Security tax: Employees and employers both owe 6.2% against $127,000 in annual worker wages.
- Medicare taxes. Employees and employers pay 1.45% each in FICA taxes, and there is no income limit.
- Medicare surcharge tax: Workers who earn more than $200,000 are subject to an additional 0.9% Medicare surcharge tax. Employers don't have to pay this tax.
Let's face facts - nobody is thrilled about paying FICA taxes, least of all self-employed individuals who have to pay 100% of the tax.
That said, the money is going to a good cause - payments to Social Security and Medicare so U.S. retirees can lead more healthy and financially comfortable lives in their post-working years.
Try thinking about that every time you look at your payroll stub and see your FICA deductions. Or better yet, don't look at them at all.