FICA Tax: What Does it Mean and How is it Calculated?
Social Security and Medicare benefits are funded by a payroll tax called the Federal Insurance Contribution Act (FICA), shared equally by employees and employers. FICA was initially created in 1935 to pay for Social Security benefits to retirees. It now covers not only retirement benefits, but also disability benefits and benefits to workers' survivors. The Medicare tax was added in 1965, helping to pay for medical coverage primarily for those aged 65 and older.
What is the FICA tax?
The FICA tax is a U.S. federal payroll tax paid by employees and their employers. It consists of:
- A 6.2% Social Security tax: This tax is referred to as Old Age, Survivors, and Disability Insurance, or OASDI. It provides benefits to retirees, disabled individuals under retirement age, spouses and former spouses, as well as dependent children (in some cases).
- A 1.45% Medicare tax: This tax allows employees to qualify for Part A Medicare coverage with no additional cost to obtain coverage through Parts B, C, and D when eligible to do so.
The FICA tax rate is applied to all taxable compensation. This includes salary, wages, tips, bonuses, commissions, and taxable fringe benefits. IRS Publication 15-B has a chart of various fringe benefits that are subject to FICA and those that are exempt (see Table 2-1).
Compensation subject to FICA also includes salary reduction contributions employees make to 401(k) or comparable plans, even though such contributions are not taxable.
What is the FICA withholding process?
Employers must withhold both the employees' share of FICA taxes as well as the employer's portion. These taxes first go through the IRS, followed by the Social Security Administration to fund retirement and disability payments. The remainder then goes to the federal government's Medicare trust, which covers medical expenses for individuals aged 65 and older, or for those who qualify for disability benefits.
What compensation is the FICA deduction applied to?
The FICA tax rate is applied to all taxable compensation. FICA taxes include salary, wages, tips, bonuses, commissions, and taxable fringe benefits. IRS Publication 15-B has a chart of various fringe benefits that are subject to FICA and those that are exempt (see Table 2-1). Compensation subject to FICA also includes salary reduction contributions employees make to 401(k) or other comparable plans.
How to calculate the FICA tax rate
FICA tax is a fixed percentage applied to compensation that's subject to this tax. The following steps explain how to calculate FICA taxes:
Step 1: Determine the compensation to which FICA is applied
Usually, FICA applies to all taxable compensation (salary, wages, commissions, bonuses, tips), including taxable fringe benefits (e.g., reimbursement for moving expenses, taxable prizes and awards) and salary reduction amounts for contributions to 401(k)s and similar plans.
Step 2: Assess whether compensation exceeds the annual Social Security wage base
If it's below the wage base for a particular employee, then the FICA tax rate applied is 7.65%. If it's above the wage base, then you need to apply the Social Security tax rate to wages up to the wage base and the Medicare tax rate to all compensation.
Step 3: Double the employee FICA tax withholdings
Whatever the tax is on employee compensation, apply an equal amount to the employer obligation for the FICA tax deductions.
What percentage of FICA taxes are Social Security withholdings?
The Social Security portion of FICA is a flat 6.2% of compensation up to a wage base limit. For 2021, the wage base is $142,800. The maximum Social Security portion of FICA an employee could pay is $8,853.60. This wage base cap changes annually to account for a cost-of-living adjustment. Again, this is the amount paid by the employee; the employer pays the same amount.
What percentage of FICA taxes are Medicare withholdings?
The Medicare portion of FICA is 1.45% of all compensation subject to this tax, as explained above. There is no wage base limit. For example, if an employee's income for purposes of this tax is $200,000, the Medicare portion of FICA is $2,900 (1.45% x $200,000). The employee and the employer each pay this amount.
FAQs about FICA taxes
Can employers deduct FICA taxes?
Employers can deduct their share of FICA as a business expense, but not the employees' share.
Can employees deduct FICA taxes?
Employees cannot deduct their FICA payments.
Do employers pay FICA taxes on employee tips?
Employers must calculate FICA on employees' tips reported to them. They are also liable for the employer share of FICA on tips that are not reported to them. This liability doesn't arise until the IRS lets you know about them. There are voluntary tip compliance programs for certain industries:
- Tip Reporting Alternative Commitment (TRAC)
- Tip Rate Determination Agreement (TRDA)
- Gaming Industry Tip Compliance Agreement (GITCA)
If the amount of tips used to calculate FICA exceeds the federal minimum requirement, you may be eligible for a FICA tip credit.
Are there additional employer responsibilities for FICA taxes?
Withholding FICA and depositing it with the government is only part of employer responsibilities for this tax. Additional responsibilities include:
- Filing employer tax returns (either quarterly or annually if you're a very small employer) to report FICA.
- Reporting Social Security and Medicare tax payments on employees' Form W-2.
Employers have no FICA responsibilities with respect to independent contractors or workers who are employees of another company (e.g., temporary workers who are employed by the temp agency).
At what income level does the FICA Medicare tax increase?
There's an additional Medicare tax on earned income of high earners. Specifically, employers must withhold 0.9% when an employee's compensation exceeds $200,000, regardless of the individual's filing status. There is no comparable employer tax payment; the withholding is only on the employee side. The employer cannot deduct any of this tax because it's paid entirely by the employee; it's merely an employer responsibility to do the withholding.
Do self-employed individuals pay FICA taxes?
Self-employed individuals do not pay FICA. Under the Self-Employed Contributions Act (SECA), which came into effect in 1954, self-employed individuals pay a comparable amount of FICA through self-employment tax to cover their Social Security and Medicare obligations. More specifically, self-employed individuals pay the employee and employer share (even though they are neither employees nor employers). One-half of self-employment tax is deductible by self-employed individuals from their gross income (no itemizing is required).
What if an employee works for two corporations that are related to each other?
Each employer must withhold the employee's share and pay the employer's share of FICA for each worker on the payroll. However, if a business is related to another corporation and an employee works for more than one of these businesses at the same time ("concurrent employment"), there's a tax strategy for the employer to save money, known as the "common paymaster rule."
What is the FICA common paymaster rule?
To use the common paymaster rule, the parties must be related. For purposes of this rule, these parties are related if any of the following four conditions are met:
- The corporations are members of a controlled group of corporations (this is based on stock ownership);
- If the corporation doesn't issue stock, then at least 50% of the board of directors of one corporation is on the board of directors of another corporation, or at least 50% of the voting power to select such members are concurrently held by holders of more than 50% respect to the other corporation;
- Fifty percent of the officers of one corporation are also officers of the other; or
- Thirty percent of employees of one corporation work concurrently for the other(s). If the related corporations agree, they can designate which one is treated as the employer, referred to as the "common paymaster," for purposes of FICA withholding. This common paymaster is responsible for FICA on the employee's wages, regardless of whether the employee receives a consolidated payment at multiple corporations or several paychecks for this work. However, all corporations in the group remain jointly and individually liable for this payroll tax.
What if an employer withholds too much FICA tax from an employee's pay?
If you over-withhold FICA from an employee's pay, you should take steps to correct the problem. Here are the options:
- Refund the excess withholding to the employee. This can be done by taking out less from the employee's paycheck to offset the excess withholding. This is usually a good option.
- File a claim with the IRS to recoup the excess payment. This may be necessary if the employee is no longer on your payroll and there are no other options to adjust future withholding.
Use Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, or Form 944-X, Adjusted Employer's Annual Federal Tax Return or Claim for Refund to make the make an adjustment in withholding or a claim for refund. If you do nothing, the employee can claim the excess payment as a tax credit on an income tax return.
How do you pay and report FICA taxes?
As an employer, you must deposit FICA and make reports about these taxes to the IRS.
- Depositing FICA. You must electronically deposit all of your payroll taxes, including FICA. There is a very limited exception for small employers with total annual payroll taxes — FICA and income tax withholding — of $1,000 or less for the full year. These employers can pay by check. The deposit schedule depends on the size of your payroll.
- Reporting FICA to the IRS. Usually you report FICA payments — withholding from your employees as well as your own — four times a year on Form 941. Again, small employees may be permitted by the IRS to file annually on Form 944.
- Reporting FICA to employees. The amount of FICA withheld from a paycheck should be reported to the employee on the pay stub. It must also be reported on the employee's Form W-2.
Is FICA Social Security?
FICA and Social Security aren't synonymous, but they are related. FICA includes the combined taxes withheld for Social Security and Medicare. FICA taxes collected by the government help fund Social Security and Medicare programs.
Managing FICA tax responsibilities
There's always a possibility that FICA tax rates could fluctuate, and/or other changes could be made, which we saw last year when the government provided payroll tax relief for employers impacted by COVID-19. Regardless of what happens in the future, consider working with a payroll provider for help with your current payroll tax responsibilities.