The Federal Insurance Contributions Act (FICA) is a US law that requires employees and employers to contribute a percentage of an employee’s income to programs such as Social Security and Medicare. These programs ensure that retirees, the disabled, and children in need receive financial benefits and assistance. Medicare is a special health insurance for people over the age of 65 years or those with disabilities. The equivalent for sole proprietors is the Self-Employed Contributions Act or SECA.
Contributions to FICA are mandatory and the percentage charged may change annually in line with inflation. FICA taxes are made on the gross income an employee receives. Generally, higher earners will be required to make higher insurance contributions, but only up to a certain limit.
Medicare and Medicaid are not the same. Medicare provides health insurance to the elderly and disabled, whilst Medicaid assists low-income households with healthcare. These income limits are based on the number of people in a household and their monthly income.
What are Social Security and Medicare tax rates?
As of 2019, the Social Security tax rate is 6.2% and Medicare is 1.45% for a combined FICA contribution of 7.65%. But this is only the employee’s half of the tax. An employer will be paying the same amount by withholding 7.65% from an employee’s earnings. The Social Security Administration announced that FICA rates would be the same in 2020. People who are self-employed pay 15.3%, which is the equivalent of both employee and employer shares of social security tax rates. All FICA rates are calculated based on gross income.
So, if your annual salary is $60,000, you would pay $4590 in FICA tax in 2019 - $3,720 would be going toward Social Security and $870 would be paid for Medicare.
Not all payments made to an employee will be subject to a FICA tax. Some exempt payments include:
- Wages for disabled workers who receive disability insurance
- Payments to underaged workers (21 years)
- Employee insurance and retirement plan contributions
- Certain payments to partners in a partnership
Social Security income cap
Because Social Security contributions are calculated based on an individual’s income, higher earners are usually required to pay in more. However, the government has installed an income cap, which means that only income up to a certain ceiling is taxable.
For 2020, the maximum income subject to Social Security taxes is $137,700, up from $132,900 in 2019. The increase is in line with inflation. These increases tend to vary from year to year. For example, in 2017 the maximum income threshold was raised by 7% compared to 1% in 2018.
However, income tax thresholds do not apply to Medicare. This means that an employee is required to pay a total of 1.45% in Medicare taxes on their earnings and an extra 0.9% on wages above $200,000. Let’s look at an example:
Say you’re employed and earned $250,000 in 2019. The income threshold for Social Security taxes was $132,900. Thus, you would be paying 6.2% on $132,900 of your gross income which is $8240. In addition, you’d be paying 1.45% in Medicare on $200,000 of your income which is $2900 and another 2.35% on the remaining $50,000 of your total gross income. Your total Medicare tax would be $4075 for 2019. Your total FICA contribution would equal $12,315. And your employer would match this payment (minus the extra 0.9% for Medicare) at $11,130.
If you want to work out your FICA contributions, you can use an online calculator.
Social security income caps have attracted much criticism due to the fact that they don’t affect very high earners, who only pay taxes on the capped portion of their income. Critics argue that lifting the cap could free up revenue which is needed to offset future shortfalls in Social Security.
The future of Social Security – why it is running out
Social Security funding is projected to run out by 2035. That’s because as more Baby Boomers retire over the coming years, they’re going to deplete the fund’s reserves at a greater speed than it is being paid into by the remaining working population. Meanwhile, Medicare is predicted to run out even sooner in 2026.
Suggestions to fix the problem and restore these programs include increasing the Social Security income cap, changing the way taxes are calculated based on income, increasing the age of retirement and raising taxes.
Self-employed contributions act (SECA)
People who are self-employed are also required to make contributions to Social Security and Medicare if their earnings are higher than $400 per quarter. In contrast to employees, for whom employers pay half of the tax, the self-employed pay the full contributions of 12.4% for Social Security and 2.9% for Medicare. However, they are allowed to deduct the half an employer would normally pay as expenses when filling out their annual tax returns. Those who earn more than $200,000 are required to pay the additional 0.9% Medicare tax on income above the threshold. The same income caps for Social Security apply to those who are self-employed.
SECA applies to all legal forms of self-employment whether a sole proprietorship, an LLC or a partnership. It’s a good idea to set aside 30% of income to make sure one can pay their Social Security and Medicaid contributions regularly.
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