FICA stands for the Federal Insurance Contributions Act. It’s the law that requires employers to withhold money from employees’ paychecks to fund Social Security and Medicare. The vast majority of people in the US who earn a wage or salary pay FICA taxes.
How does FICA work?
The Federal Insurance Contributions Act was passed in 1935 to create a funding mechanism for Social Security. However, the federal government did not begin to collect FICA payroll taxes until 1937. Since then, a Medicare payroll tax was added in 1965 to contribute to Medicare costs.Â
In essence, FICA taxes are designed to “provide a fallback security blanket to be covered financially and medically in old age,” says Crystal Stranger, an enrolled agent and author ofÂ “The Small Business Tax Guide.”
While not meant to be a sole source of income after retirement, for workers who pay into these safety net programs, the extra funds and access to medical care in retirement or in the face of a disability can make a big difference.
The vast majority of people working in the US â including the self-employed â have to payÂ FICA taxes. But there are a few exceptions including these:
- You won’t have to pay full FICA taxes on more than $142,800 of wages in 2021.Â
- If the organization you work for qualifies for a specific religious exemption, you won’t have to pay FICA taxes.Â
- Nonresident aliens working in the US may not have to pay FICA taxes on their income.Â
- College students working a part-time job on campus may not have to pay FICA taxes depending on their enrollment status.
What are the FICA tax rates and limits?Â
When you look at your paycheck, you’ll see that your FICA taxes are taken out of your gross wages. Most employees will see 6.2% taken out for Social Security and 1.45% for Medicare, for a total of 7.65%. Employers match those amounts, for a total of 15.3% of the average salary.
For higher-income taxpayers, there’s a cap on the amount taken for Social Security, and an additional levy paid only by the employee for the Medicare portion.
Here’s a breakdown of the FICA tax rates and limits for the 2021 and 2022 tax year:
How is the FICA tax calculated?Â
Here’s an example of how FICA taxes could be withheld from a worker who earned $165,000 in 2021:
Instead of paying FICA taxes on the full $165,000, the employee would only have to pay Social Security taxes on the wage base limit of $142,800.
With that limit in mind, the employee would pay 6.2% in Social Security taxes on $142,800, leading to a total of $8,853.60.Â Additionally, they would pay 1.45% in Medicare taxes on the entire gross pay, for a total of $2,392.50. All in all, they would contribute $11,246.10 in FICA taxes.
But remember that the employer would match the tax contributions for both. When that’s included, the employee’s earnings would lead to $22,492.20 in FICA taxes.
Although this is a case with a relatively high earner, you can easily see how quickly FICA taxes can add up.Â
How to pay the FICA taxes if you’re self-employed
What if you don’t have a traditional employer to pick up half of the total FICA tax tab? If you are self-employed, you’ll still have to contribute funds to Social Security and Medicare. However, the taxes are levied on your net earnings instead of gross pay.
The Social Security and Medicare taxes are the same rates â 6.2% and 1.45%, respectively. But without a traditional employer in the picture, you’ll be left to pay both halves of these by yourself. With that, you’ll be footing the entire 15.3% total tax.
The good news is that you can deduct half of the self-employment tax as an adjustment on Schedule 1 of Form 1040.
As you don’t have withholding when you are self-employed and both halves of the FICA tax are added to your income tax liability on your federal tax return, this substantial amount can come as quite a surprise for some newly self-employed people at tax time.
The financial takeaway
FICA taxes are a mandatory expense that can take a dent out of your budget, so don’t forget about them when considering how much tax you actually pay.
As a traditional employee, the deductions from your paycheck may soften the blow. But self-employed people may run into a significant expense when tax time rolls around.Â