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What is the FICA tax?

Thursday, December 02, 2021

When it comes to running your business, there are many things you are responsible for – from setting up your business properly to paying employees. One of these responsibilities when it comes to payroll is taxes. This includes withholding the right amount of money from employees for income taxes and other payroll taxes. One of these taxes is the FICA tax. So in this article, we’ll talk about the FICA tax – what it is, the tax rates associated with FICA, and special considerations for FICA tax exemptions. To start, let’s define the FICA tax. 

What is FICA?

FICA stands for the Federal Insurance Contributions Act, which the federal government passed in 1935. This federal law governs the payment of Social Security and Medicare taxes and mandates that taxes should be withheld from paychecks to fund these programs. FICA tax is different from the federal income tax. As the FICA tax is the primary funding vehicle for Medicare and social security benefits, it helps support retirees, the disabled and children who qualify for these programs. While many will receive these benefits once they’re retired, employees fund the programs while they’re working. But, the FICA tax isn’t just funded by employees. Employers like you also have to contribute to the FICA tax.

When you withhold these payroll taxes from your employees' paychecks and pay them to the Internal Revenue Service (IRS), they then get distributed to both the Social Security Administration and the federal government’s Medicare trust. Those programs then disburse the funds appropriately to those who qualify for Medicare programs and Social Security benefits. The Social Security tax is sometimes referred to as the Old Age, Survivors, and Disability Insurance (OASDI) tax.

But are FICA taxes mandatory? You might wonder if your small business has to pay these taxes, and the answer is yes. As a federally mandated tax, your business is required by law to pay these FICA taxes unless it meets specific exemption requirements (more on that later). Now that you know more about the FICA tax let’s dive deeper into the FICA tax rates.

What are the FICA tax rates?

As you can probably tell, the FICA tax consists of two separate taxes; one for Medicare and one for Social Security. Because of this, there are a few different taxes that your business and your employees will have to pay. FICA taxes are split evenly between the employee and employer portions, so employees and employers pay the same amount in FICA taxes per paycheck. The Social Security tax rate is 6.2% and the Medicare tax rate is 1.45%. When you take into account the matching employee and employer contributions, that adds up to a total of 15.3%. 

The government uses an individual’s gross income as the starting point for FICA taxes. There are thresholds and other wage caps to consider when calculating FICA taxes. As of the 2021 tax year, the gross annual pay cap for the social security portion was $142,800. That means that any additional wages above this Social Security wage base aren’t subject to withholding social security taxes. You don’t have to pay any employer taxes on wages above that amount. However, when it comes to Medicare taxes, there’s no cap, so all of an employee’s annual wages are subject to the Medicare tax.
 
There’s also an additional Medicare surtax for employees who make over a certain amount of money each year. Once an employee’s wages reach $200,000, your business must withhold 0.9% on any wages above that amount. There’s no match for employers in this case, making the employee solely responsible for the Medicare surtax.
Let’s look at a simple example to see how to calculate FICA taxes. Your company, Joe’s Insurance Co., employs someone who has an annual salary of $100,000.
 

The amount of tax withholding from that employee for the year is as follows:

  • To get social security taxes, multiply 6.2% times $100,000 for a sum of $6,200.
  • To get Medicare taxes, multiply 1.45% times $100,000 for a sum of $1,450

Total taxes withheld from the employee (what the employee pays) = $7,650

Now, we have to figure out how much you, as the employer, are responsible for:

  • To get social security taxes, multiply 6.2% times $100,000 for a sum of $6,200.
  • To get Medicare taxes, multiply 1.45% times $100,000 for a sum of $1,450. 

Total employer FICA taxes (what the employer pays) =  $7,650

You'll divide these yearly numbers into per pay period amounts and report these numbers on an employee's pay stub. Using IRS form 941, you'll then report these numbers to the IRS every quarter for all employees.  This form helps businesses report the amount of money that you withhold from the employee and the amount of taxes you’re paying as an employer. The amount you withhold from your employee may differ slightly based on your employee's tax filing status and the withholdings they declare on their form W-4. As always, it’s best to consult your tax advisor for information regarding your business’s specific situation.

Are there FICA tax exemptions?

While businesses are typically responsible for paying FICA taxes, there are certain exemptions that make some payments not subject to FICA taxes. These situations include:

  • Children under age 18 who are employed by their parents
  • Qualified retirement plan contributions from employers
  • Service performed by students employed by a school, college or university
  • Some church and qualified church-controlled organization wages
  • Some state and local government salaries

Employees who are exempt from FICA won’t have to pay FICA taxes but are exempt from receiving benefits of the FICA system. Again, these are typically rare cases where businesses are exempt from paying the FICA tax. Now, let’s take a look at paying FICA taxes as a small business.

How to pay FICA taxes

When it comes to your responsibilities as a small business owner to pay FICA taxes, it’s a relatively straightforward process. First, you’ll calculate your FICA tax liability. Anything over $2,500 per quarter, and you’ll have to use the IRS’s Electronic Federal Tax Payment System (EFTPS) to deposit FICA taxes. These deposits will happen periodically, and you’ll pay both your share of the taxes as well as the employee’s withholding amount. One important note for small business owners: businesses less than a year old must follow a monthly deposit schedule. FICA tax deposit schedules vary by business. To learn more about your business’s specific instance, you can consult IRS publication 15.

FICA taxes vs. self-employment taxes (SECA)

As a business owner, a unique component of your taxes is your obligation as a self-employed business owner. If you meet the requirements, you contribute to Social Security and Medicare by paying self-employment taxes (SECA taxes). If you actively work in a corporation, you’re typically seen as an employee subject to withholding for both income taxes and FICA taxes. However, the IRS considers the following to be self-employed:

  • Owner of a sole proprietorship or independent contractor
  • General partner in a partnership
  • Member of a limited liability company (unless the LLC is taxed as a corporation)
If you do pay SECA taxes, they essentially just add up the employer and employee share of FICA taxes. But fortunately, self-employed business owners can deduct half of their SECA taxes on their income tax returns.
 

What happens in the case of underpayments or overpayments?

Sometimes, employers may overpay or underpay FICA taxes. Luckily, there’s a remedy to fix these situations. If the employer discovers the error after completing a tax year, the employer will send a corrected W-2 form to the employee.   In the case of underpaying, the employer would make the necessary adjustments and pay the extra amount to the quarter when the error happened. The employer can also make the same adjustments to its share of FICA taxes. 

In the case of overpayment, an employer can adjust or seek a credit or refund of the employer’s share of FICA. If an employee overpays, they should expect to see a refund on their tax return.

As you can see, FICA taxes are an important part of doing business. You can also see how complicated it is to make sure your business is calculating, paying and withholding correctly. Therefore, many small business owners like you opt to work with a payroll software or work with a partner who can help them stay in compliance with the IRS’s withholding and filing requirements while also helping to make the necessary payments.

When it comes to business taxes, staying on top of things can be a hassle. But after reading this article, you should have a better grasp on the FICA tax, including what it is, how it’s calculated, and what legal requirements you have to follow as a business owner. To remove headaches from doing the work yourself, look to payroll software or professionals who can demystify taxes so you can focus on your business.


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