FICA: Understanding your Check’s Payroll Taxes

FICA: Understanding your Check's Payroll Taxes

Most Americans, after working their first job for a few weeks, are super excited to open their very first paycheck. After all, that’s what they’ve been working for! But then, they open their paycheck and think, “What is FICA?” and, “Where did all my money go?”

jennifer aniston paycheck FICA confusion

So, what (not who) is FICA? Where is your money going? Will you ever see it again? Can you get out of paying it? These are common questions, and I’m here to answer them and more!

What is FICA?

FICA stands for the Federal Insurance Contributions Act, created in 1935 as part of the Social Security Act. It was originally called Title VIII in the Social Security Act but got its own name in 1939. Medicare was later added after its creation in 1965.

This act came on the heels of the Great Depression. It helped create a government safety net for those who had no money and were unable to work.

Today, two federal payroll taxes make up the Federal Insurance Contributions Act (FICA): Social Security (OASDI) and Medicare. So, how does FICA work?

When someone receives a paycheck, their employee automatically withholds their FICA taxes. Unlike federal and state income taxes (W-4, for example), there are no forms related to FICA. Instead, everyone pays a flat tax. These taxes are based on an employee’s gross pay. Because FICA is not an income tax, there are no deductions or income exemptions.

The FICA Flat Tax

The social security portion, also known as OASDI (Old-Age, Survivors, and Disability Insurance) has a 6.2% flat tax. Likewise, Medicare, also known as HI (Hospital Insurance), has a 1.45% flat tax.

By flat tax, I mean FICA taxes employees at those specific rates, regardless of their income, making it a “regressive” tax. This is contrary to the United States income tax, which is progressive (tax rates increase with higher income).

\textup{Social Security Tax}=\textup{Gross Income}\times 6.2\%

\textup{Medicare Tax}=\textup{Gross Income}\times 1.45\%

\textup{FICA}=\textup{Social Security Tax}+\textup{Medicare Tax}

For example, suppose Laura’s gross income (income before taxes and deductions) is $50,000. Her yearly FICA contributions would be $3,100 towards Social Security and $725 towards Medicare, for a total of $3,825, as shown below.

\textup{Medicare Tax}=\$50000\times 6.2\%=\$3100

\textup{Medicare Tax}=\$50000\times 1.45\%=\$725

\textup{FICA}=\$3100+\$725=\$3825

The social security portion of the tax has one exception: the IRS does not collect social security taxes above the social security wage base (an inflation-adjusted income threshold). For example, in 2018, the social security wage base is $128,400. So, once someone’s income passes $128,400 in 2018, they stop paying social security tax until their income resets the next year.

Additional Medicare Tax

Medicare has no max limit. In fact, if you make enough money, Medicare taxes can actually increase! In 2013, the Affordable Care Act (aka “Obamacare”) created the Additional Medicare Tax. The IRS applies this 0.9% tax on any income that surpasses a threshold based on your tax filing status. Below, you can find the different thresholds for 2018.

Filing StatusThreshold Amount
Married Filing Jointly
$250,000
Married Filing Separately$125,000
Single$200,000
Head of Household$200,000
Qualifying Widow(er) with dependent child$200,000

Once someone’s household or individual income surpasses the relevant threshold above, the employee must pay the 0.9% Additional Medicare Tax.

Since Medicare is a payroll tax, your employer must deduct this Additional Medicare Tax from your paycheck once you your income passes $200,000, regardless of your filing status. Because of this, the Additional Medicare Tax can cause people to be very over- or under-taxed by the end of the year.

Additional Medicare Tax Examples

Additional Medicare Tax Example 1: John and Sally are married and file their taxes jointly. John makes $150,000 per year, and Sally makes $150,000 per year. In total, they bring in $300,000 per year, which is above their $250,000 threshold, so they must pay the Additional Medicare Tax on the extra $50,000. But, because neither of them made more than $200,000 individually, neither of their employers withheld the money from their paychecks. John and Sally have now been under-taxed and will owe more money at tax time ($50,000 x 0.9% = $450).

Additional Medicare Tax Example 2: John and Sally are married and file their taxes jointly. John makes $210,000 per year, and Sally makes $40,000 per year. In total, they bring in $250,000 per year, which is not above their $250,000 threshold, so they don’t need to pay the Additional Medicare Tax. But, because John made more than $200,000 individually, his employer withheld 0.9% of the last $10,000 he made. John and Sally have now been over-taxed and should receive a tax refund for this.

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The Employer FICA Match

FICA doesn’t just take money from employees. No, employer must pay their share too. In fact, employees only pay half of the total FICA tax, with the employer contributing the other half. This means the government gets twice as much. Instead of receiving 7.65% of your gross pay, they actually get 15.3% with the employer contribution.

Because of this employer match, the more an employer pays an employee, the more they must pay in FICA taxes.

 Do the Self-Employed Pay FICA?

Self-employed workers are not exempt from paying Social Security and Medicare taxes, but they don’t call it FICA. Instead, self-employed individuals are subject to the Self-Employed Contributions Act (SECA). SECA was created in 1954 and has the same rates as FICA. But, because they’re self-employed, they need to pay the full 15.3%. However, 7.65% of the tax (the employer portion) is tax-deductible as a business expense. So, the self-employed typically only pay SECA taxes on 92.35% of their net earnings.

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What About Investment Income?

Investment income, like stock dividends or bank interest, are not subject to FICA taxes. So, if a bulk of your income comes from investments and not from a business you work for or own, you won’t pay nearly as much in FICA taxes. This is one of the ways those with a lot of wealth can avoid certain taxes. Basically, you can pay less in taxes on $50,000 in dividends than on $50,000 from a basic salary.

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FICA Payroll Tax Calculator

Don’t want to do the math by hand? No problem! Check out this handy FICA Tax calculator I put together just for you!

TL;DR

FICA taxes are payroll taxes consisting of both Social Security and Medicare taxes. They are automatically withheld from your check by your employer and find their origin in the 1935 Social Security Act.

FICA is a flat tax on your gross income, with 6.2% going towards Social Security and 1.45% going towards Medicare. Because it is not an income tax, there are no deductions on the taxable amount. The social security portion of FICA has a “Social Security Wage Base,” which limits the taxable amount. In 2018, the Social Security Wage Base is $128,400, which means any income earned beyond $128,400 is not taxed for Social Security. Medicare has no limit, and any income above $200,000 per year is taxed at an additional 0.9% (appropriately called the “Additional Medicare Tax”). The amount of Additional Medicare Tax one is subject to depends on one’s filing status, but employers will start withholding at $200,000, regardless of filing status.

Employers also need to match the FICA tax, contributing their own 6.2% and 1.45% of your gross income. As a result, the government gets 15.3% of your gross income in FICA revenue. Self-employed workers also need to pay Social Security and Medicare taxes, but they do this through the Self-Employed Contributions Act (SECA), a program equivalent to FICA.

Investment income, like dividends and interest, does not require FICA taxes. This is one way those with a lot of wealth and investment income can keep more of their money away from taxes.

What do you think about FICA? Did you learn something new in this article? Let me know in the comments below!