FICA Tax

FICA Tax (Federal Insurance Contributions Act Tax) is a U.S. federal payroll tax that funds Social Security and Medicare programs. It is shared between employers and employees, with each contributing a portion of the employee’s earnings.

1. Employee and Employer Contributions: FICA tax is split between the employee and employer, each paying a percentage of the employee’s wages.
2. Social Security and Medicare Funding: FICA tax directly funds Social Security and Medicare, which provide benefits to retirees, disabled individuals, and those with certain medical conditions.
3. Mandatory Compliance: All U.S. businesses with employees are required to comply with FICA tax regulations, ensuring that the appropriate amounts are withheld and paid.

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How is the FICA Tax structured?

Employee and Employer Contributions

FICA tax consists of two components: Social Security and Medicare. The current rate for Social Security is 6.2% of the employee’s gross income, and for Medicare, it is 1.45%. Both employees and employers contribute to FICA taxes, with each paying 7.65% of the employee’s gross income.

Wage Base Limit for Social Security

Social Security taxes apply only to income up to a certain limit, known as the wage base limit, which changes annually. Incomes above this limit are not subject to the Social Security portion of FICA. For 2024, the limit is $168,600. Wages beyond that are not subject to the social security portion of the taxes.

No Wage Base Limit for Medicare

Unlike Social Security, the Medicare portion of FICA has no wage base limit, meaning all earned income is subject to the 1.45% tax. An additional 0.9% Medicare tax applies to high earners above a certain threshold. The Additional Medicare Tax is for individuals with income above $200,000 or married couples (filing jointly) with income above $250,000.

AKA the Self-Employment Tax

For self-employed individuals, the FICA tax is known as the Self-Employment Tax and it covers both the employee and employer portions of FICA. Self-employed individuals pay a total of 15.3% in self-employment tax, which includes 12.4% for Social Security and 2.9% for Medicare. The same thresholds apply for wage base limit for social security and additional medicare tax for self-employed individuals.

Although self-employed individuals pay the full 15.3%, they can deduct the "employer" portion (7.65%) when calculating their income taxes, which helps reduce the overall tax burden.

Taxed on Income Pre-Retirement Contributions

FICA taxes are applied to pre-retirement contributions like 401(k) contributions. This means that even though 401(k) contributions are made on a pre-tax basis, they are still subject to FICA taxes. In other words, FICA taxes are calculated based on your gross earnings before any 401(k) contributions are deducted.

However, once you're retired and begin withdrawing from your 401(k), those withdrawals are not subject to FICA taxes, though they may be subject to income tax.

What is the FICA Tax for?

Social Security and Medicare Funding

The funds collected from FICA tax are used to support Social Security and Medicare programs, which provide financial support and healthcare to eligible individuals. Social Security provides retirement benefits, disability income, and survivor benefits, while Medicare offers health insurance to those over 65 and to some younger individuals with disabilities. For a business owner, contributing to these programs is not just a legal obligation but also a contribution to the broader social safety net.

The beneficiaries of the FICA tax can be generalized as:

• Retirees: Social Security provides retirement income to individuals who have worked and paid into the system through FICA taxes during their working years. These benefits help retirees maintain financial stability after they stop working.
• Disabled Individuals: Social Security also provides disability benefits to people who are unable to work due to a qualifying disability. This ensures they have a source of income despite being unable to earn a living.
• Survivors: Social Security offers benefits to the survivors of deceased workers, such as spouses and dependent children, providing financial support to families after the loss of a wage earner.
• Medicare Beneficiaries:  Medicare provides health insurance primarily to those 65+ years old and to some younger people with disabilities. It covers various healthcare costs, including hospital stays, medical services, and prescription drugs.
• Current Workers: Although current workers pay FICA taxes, they also benefit indirectly by earning credits toward their future Social Security and Medicare benefits, ensuring they have a safety net when they retire or if they become disabled.

Mandatory Compliance

Compliance with FICA tax is non-negotiable for U.S. businesses with employees. Not properly accounting for FICA tax in a timely manner can lead to penalties and fines. For self-employed individuals, small businesses, and startups, it’s essential to ensure that payroll systems are set up to automatically calculate and remit these taxes to avoid compliance issues.

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