Federal Insurance Contributions Act tax

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Federal Insurance Contributions Act (FICA) tax /ˈfkə/ is a United States federal payroll (or employment) tax[1] imposed on both employees and employers to fund Social Security and Medicare[2] —federal programs that provide benefits for retirees, the disabled, and children of deceased workers. The tax also provides funds to the health care system for institutions that provide healthcare for workers that do not have health insurance and can not afford healthcare treatment. Social Security benefits include old-age, survivors, and disability insurance (OASDI); Medicare provides hospital insurance benefits for the elderly. The amount that one pays in payroll taxes throughout one's working career is associated indirectly with the social security benefits annuity that one receives as a retiree.[3] This has caused some to claim that the payroll tax is not a tax because its collection is tied to a benefit.[4] The United States Supreme Court decided in Flemming v. Nestor (1960) that no one has an accrued property right to benefits from Social Security. The Federal Insurance Contributions Act is currently codified at Title 26, Subtitle C, Chapter 21 of the United States Code.[5]

How the tax is calculated[edit]

Overview[edit]

Share of federal revenue from different tax sources. Individual income taxes (blue), payroll taxes/FICA (green), corporate income taxes (red).[6]

The Center on Budget and Policy Priorities states that three-quarters of taxpayers pay more in payroll taxes than they do in income taxes.[7] The FICA tax is considered a regressive tax on income with no standard deduction or personal exemption deduction. It is imposed on only the first $113,700 of gross wages in 2013 and $117,000 in 2014. The tax is not imposed on investment income such as interest and dividends.

Regularly employed people[edit]

For 2014, the employee's share of the Social Security portion of the FICA tax is 6.2% of gross compensation up to a limit of $117,000 of gross compensation (resulting in a maximum Social Security tax of $7,254).[8] This limit, known as the Social Security Wage Base, goes up each year based on average national wages and, in general, at a faster rate than the Consumer Price Index (CPI-U). For the calendar years of 2011 and 2012, the employee's share was temporarily reduced to 4.2% of gross compensation with a limit of $106,800 for 2011 and $110,100 for 2012.[9] The employee's share of the Medicare portion of the tax is 1.45% of wages, with no limit on the amount of wages subject to the Medicare portion of the tax.[10] Because some payroll compensation is subject to state income tax withholding in addition to Social Security tax withholding and Medicare tax withholding, the Social Security and Medicare taxes account for only a portion of the total percentage an employee constructively pays.

The employer is also liable for 6.2% Social Security and 1.45% Medicare taxes,[11] making the total Social Security tax 12.4% of wages and the total Medicare tax 2.9%. (Self-employed people are responsible for the entire FICA percentage of 15.3% (= 12.4% + 2.9%), since they are in a sense both the employer and the employed; however, see the section on self-employed people for more details.)

If a worker starts a new job halfway through the year and during that year has already earned an amount exceeding the Social Security tax wage base limit with the old employer, the new employer is not allowed to stop withholding until the wage base limit has been earned with the new employer (that is, without regard to the wage base limit earned under the old employer). There are some limited cases, such as a successor-predecessor employer transfer, in which the payments that have already been withheld can be counted toward the year-to-date total.

If a worker has overpaid toward Social Security by having more than one job or by having switched jobs during the year, that worker can file a request to have that overpayment counted as a credit for tax paid when he or she files a federal income tax return. If the taxpayer is due a refund, then the FICA tax overpayment is refunded.

Self-employed people[edit]

The effective payroll tax rate based on private simulations for different income groups. Effective tax rate equals the payroll taxes paid divided by total income. Total income includes traditional measures of income, imputed undistributed corporate profits, nontaxable employee benefits, income of retirees, and nontaxable income. Payroll taxes include employee and employer FICA.[13]

A tax similar to the FICA tax is imposed on the earnings of self-employed individuals, such as independent contractors and members of a partnership. This tax is imposed not by the Federal Insurance Contributions Act but instead by the Self-Employment Contributions Act of 1954, which is codified as Chapter 2 of Subtitle A of the Internal Revenue Code, 26 U.S.C. § 1401 through 26 U.S.C. § 1403 (the "SE Tax Act"). Under the SE Tax Act, self-employed people are responsible for the entire percentage of 15.3% (= 12.4% [Soc. Sec.] + 2.9% [Medicare]); however, the 15.3% multiplier is applied to 92.35% of the business's net earnings from self-employment, rather than 100% of the gross earnings; the difference, 7.65%, is half of the 15.3%, and makes the calculation fair in comparison to that of regular (non-self-employed) employees. It does this by adjusting for the fact that employees' 7.65% share of their SE tax is multiplied against a number (their gross income) that does not include the putative "employer's half" of the self-employment tax. In other words, it makes the calculation fair because employees do not get taxed on their employers' contribution of the second half of FICA, therefore self-employed people should not get taxed on the second half of the self-employment tax. Similarly, self-employed people also deduct half of their self-employment tax (schedule SE) from their gross income on the way to arriving at their adjusted gross income (AGI). This levels the amount paid by self-employed persons in comparison to regular employees, who do not pay general income tax on their employers' contribution of the second half of FICA, just as they did not pay FICA tax on it either.[14][15]

These calculations are made on Schedule SE: Self-Employment Tax, although that is not readily apparent to novice self-employed taxpayers, owing to the schedule's rather opaque name, which makes it sound like it is part of the general federal income tax. Some taxpayers have complained that Schedule SE's title should be changed to something such as "Self-Employment FICA Tax", so that its separateness from the general income tax is apparent,[citation needed] perhaps not realizing that the SE tax is not imposed by the Federal Insurance Contributions Act (FICA) at all, and that neither SE taxes nor FICA taxes are "income taxes" imposed under Chapter 1 of the Internal Revenue Code.

Exemption for certain full-time students[edit]

A special case in FICA regulations includes exemptions for student workers. Students enrolled at least half-time in a university and working part-time for the same university are exempted from FICA payroll taxes, so long as their relationship with the university is primarily an educational one.[16] Medical residents working full-time are not considered students and are not exempt from FICA payroll taxes, according to a US Supreme Court ruling in 2011.[17] In order to be exempt from FICA payroll taxes, a student's work must be "incident to" pursuit of a course of study, which is rarely the case with full-time employment.[17]

Exempted government employees[edit]

A number of state and local employers and their employees in the states of Alaska, California, Colorado, Illinois, Louisiana, Maine, Massachusetts, Nevada, Ohio and Texas are currently exempt from paying the Social Security portion of FICA taxes. They provide alternative retirement and pension plans to their employees. FICA initially did not apply to state and local governments, which were later given the option of participating. Over time, most have elected to participate but a substantial number remain outside the system.[18]

History[edit]

Historical payroll tax rates for Social Security (blue), Medicare (red) and total (purple). The tax rates shown include both employee and employer contributions.[19]

Prior to the Great Depression, the following presented difficulties for Americans: [20]

  • The U.S. had no federal-government-mandated retirement savings; consequently, for those people who had not voluntarily saved money throughout their working lives, the end of their work careers was the end of all income.
  • Similarly, the U.S. had no federal-government-mandated disability income insurance to provide for citizens disabled by injuries (of any kind—non-work-related); consequently, for most people, a disabling injury meant no more income (since most people have little to no income except earned income from work).
  • In addition, there was no federal-government-mandated disability income insurance to provide for people unable to ever work during their lives, such as anyone born with severe mental retardation.
  • Further, the U.S. had no federal-government-mandated health insurance for the elderly; consequently, for many people, the end of their work careers was the end of their ability to pay for medical care.

In the 1930s, the New Deal introduced Social Security to rectify the first three problems (retirement, injury-induced disability, or congenital disability). It introduced the FICA tax as the means to pay for Social Security.

In the 1960s, Medicare was introduced to rectify the fourth problem (health care for the elderly). The FICA tax was increased in order to pay for this expense.

In December 2010, as part of the legislation that extended the Bush tax cuts (called the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the government negotiated a temporary, one-year reduction in the FICA payroll tax. In February 2012, the tax cut was extended for another year.[21]

In March 2014, the Supreme Court reversed a lower court decision in U.S. v. Quality Stores, Inc. The court held that severance packages are taxable wages for FICA purposes. [22]

Criticism[edit]

Social Security regressivity debate[edit]

The Social Security component of the FICA tax is regressive, meaning the effective tax rate regresses (decreases) as income increases beyond the compensation limit.[23] The Social Security component is a flat tax for wage levels under the Social Security Wage Base (see "Regular" employees above). Since no tax is owed on wages above the Wage Base limit, the total tax rate declines as wages increase beyond that limit. In other words, for wage levels above the limit, the absolute dollar amount of tax owed remains constant.

FICA tax also is not collected on unearned income, including interest on savings deposits, stock dividends, and capital gains such as profits from the sale of stock or real estate. The proportion of total income which is exempt from FICA tax as "unearned income" tends to rise with higher income brackets.

Some argue that since Social Security taxes are eventually returned to taxpayers, with interest, in the form of Social Security benefits, the regressiveness of the tax is effectively negated.[citation needed] That is, the taxpayer gets back what he or she put into the Social Security system. Others, including The Economist and the Congressional Budget Office, point out that the Social Security system as a whole is progressive in the lower income brackets; individuals with lower lifetime average wages receive a larger benefit (as both a percentage of their lifetime average wage income and a percentage of Social Security taxes paid) than do individuals with higher lifetime average wages.[24][25][26]

See also[edit]

References[edit]

  1. ^ The FICA tax is imposed under the Federal Insurance Contributions Act, which is codified as I.R.C. ch. 21
  2. ^ Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 367. ISBN 0-13-063085-3. 
  3. ^ "Policy Basics: Federal Payroll Taxes". Center on Budget and Policy Priorities. April 15, 2013. Retrieved November 17, 2013. 
  4. ^ Kevin A. Hassett, March 29, 2005, "Is the Payroll Tax a Tax?" National Review Online, at [1].
  5. ^ CHAPTER 21—Federal Insurance Contributions Act from the Legal Information Institute at Cornell Law School
  6. ^ JCX-49-11, Joint Committee on Taxation, September 22, 2011, pp 4, 50. http://www.jct.gov/publications.html?func=startdown&id=4363
  7. ^ Studies Shed New Light on Effects of Administration's Tax Cuts by David Kamin and Isaac Shapiro, Center on Budget and Policy Priorities, Revised September 13, 2004
  8. ^ U.S. Social Security Administration, at [2].
  9. ^ IRS Publication 15 (2011)
  10. ^ Revenue Code Section 3101. Tax Almanac.
  11. ^ Internal Revenue Code Section 3111. Tax Almanac.
  12. ^ "OASDI and SSI Program Rates & Limits, 2014". Ssa.gov. Retrieved 2014-04-15. 
  13. ^ Table T11-0099, Effective Federal Tax Rates Under Current Law, By Total Income Percentile, 2010, Tax Policy Center. http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2980
  14. ^ I am self-employed. How do I pay Social Security tax?. Social Security Administration. Retrieved on April 28, 2007.
  15. ^ Self-Employment Tax. Internal Revenue Service. Retrieved on April 28, 2007.
  16. ^ Rev. Proc. 2005-11 (pdf). Internal Revenue Service. Page 5. April 1, 2005.
  17. ^ a b Mayo Foundation for Medical Education and Research Et Al. v. United States (pdf). Supreme Court of the United States. January 11, 2011.
  18. ^ The FICA Free-Lunch Crowd, Girard Miller, Governing, August 12, 2010.
  19. ^ Tax Policy Center (2011-03-23). "Historical Payroll Tax Rates". Taxpolicycenter.org. Retrieved 2014-04-15. 
  20. ^ Historical Background and Development of Social Security Social Security Administration
  21. ^ "Congress passes extension of payroll tax cut, unemployment benefits". CBS News. 
  22. ^ UNITED STATES v. QUALITY STORES, INC. et al. by the Supreme Court of the United States, retrieved May 2, 2014
  23. ^ Social Security Snares & Delusions by Irwin Stelzer, The Weekly Standard. Retrieved July 23, 2008
  24. ^ Is Social Security Progressive? by the Congressional Budget Office, retrieved July 23, 2008
  25. ^ Slemrod, Joel E. "Progressive Taxes". Concise Encyclopedia of Economics. Retrieved March 24, 2012. "[T]he progressivity of the tax structure cannot be judged by looking at only one component of taxes.... In recent years the fastest-growing component of federal taxes has been the payroll tax, which is regressive (the opposite of progressive) in its impact, because it taxes at a flat rate only on wages below $63,400 (in 1991). The Social Security system, however, is progressive because it pays higher benefits—relative to taxes paid in—to lower-income workers." 
  26. ^ "Are Social Security taxes regressive?". The Economist. April 14, 2009. Retrieved March 24, 2012. 

External links[edit]