Legal Definitions - FICA Tax

FICA Tax stands for the Federal Insurance Contributions Act Tax. These are mandatory payroll taxes deducted from most workers' wages and paid by employers in the United States. The primary purpose of FICA taxes is to fund two crucial federal programs:

• Social Security: This program provides retirement benefits, disability income, and survivor benefits to eligible individuals and their families.
• Medicare: This program offers health insurance coverage primarily for individuals aged 65 or older, and for some younger people with disabilities.

FICA taxes are composed of two distinct parts:

• Social Security Tax: A percentage of an employee's wages, up to an annual maximum earnings limit. This tax is typically split, with the employee paying one portion and the employer paying an equal portion.
• Medicare Tax: A percentage of all an employee's wages, with no annual earnings limit. This tax is also typically split between the employee and employer. Additionally, employees with higher incomes pay an extra Medicare tax on earnings above a certain threshold.

For individuals who are self-employed, they are responsible for paying both the employee and employer portions of FICA taxes, often referred to as "self-employment tax." However, they can deduct a portion of these taxes as a business expense.

Here are a few examples to illustrate how FICA taxes apply in different situations:

• Example 1: Standard Employee

  A marketing specialist earns an annual salary of $70,000. Each payday, her employer withholds her share of FICA taxes directly from her paycheck. This includes her portion of both Social Security and Medicare taxes, calculated based on her wages. Simultaneously, her employer contributes an equal, matching share of FICA taxes on her behalf. This demonstrates the typical split of FICA tax responsibility between an employee and their employer for wages below the annual Social Security cap and the high-income Medicare threshold.

• Example 2: High-Income Employee

  A senior executive earns $300,000 per year. For the Social Security portion of FICA, her contributions will cease once her cumulative earnings for the year reach the annual Social Security wage cap. However, for Medicare, both she and her employer will continue to pay the standard Medicare tax on all $300,000 of her wages, as there is no wage limit for Medicare. Furthermore, because her income exceeds $200,000, she will also be responsible for paying an additional employee-only Medicare tax on the portion of her income above that threshold.

• Example 3: Self-Employed Individual

  A freelance graphic designer operates her own business and has a net income of $50,000 for the year. As a self-employed individual, she is responsible for paying both the employee and employer portions of FICA taxes on her net earnings. She calculates and pays these "self-employment taxes" quarterly to the IRS. When she files her annual income tax return, she can claim a deduction for the employer-equivalent portion of her FICA taxes, reducing her overall taxable income.