Do you ever wonder where exactly the money that is deducted from your gross pay goes? It can seem like a huge chunk when your gross pay and net pay are $100 or more off. So where is this money that is being taken from your paycheck really going? Read on to understand the basics of FICA, Medicare, and Social Security tax.
FICA Tax
FICA is an acronym for Federal Insurance Contributions Act. This act was introduced in 1930 to cover Social Security. Both you and your employer will pay into this tax. Now, the tax is divided into Medicare and Social Security tax which is why you will probably see these two items on your paystub rather than just FICA. In 2019, the tax rate for employees was 1.45% for Medicare and 6.2% for Social Security. High-income employees are charged an additional 0.9% Medicare surtax.
In 1935, the legislation that established the FICA tax was passed. The money is utilized to offer working Americans a retirement savings and insurance scheme. The main source of funding for Social Security benefits, according to Cincinnati-based certified financial planner Ben Dobler of Stewardship Financial Counsel, is FICA taxes. FICA taxes are also used to fund Social Security and the Medicare program.
The FICA tax is intended to help retirees who are eligible for benefits. “You gain credits for Social Security benefits when you work and earn and then pay your FICA taxes,” explains Michael Hammelburger, CEO of Bottom Line Group in Baltimore. To qualify for a Social Security credit in 2022, you must earn at least $1,510 and pay FICA taxes on that amount. You can obtain up to four credits per year. Once you have earned at least 40 credits, you will be eligible to collect Social Security retirement benefits beginning at the age of 62.
Paying FICA taxes entitles you to disability and life insurance benefits as well. Provided you become disabled, you may be eligible for Social Security disability payments if you meet specific conditions and have the required amount of Social Security credits. If you die, your qualified family members, such as minor children and a surviving spouse who cares for small children or is 60 or older, may be eligible for Social Security survivor payments.
Employers have the responsibility of withholding FICA taxes from their employees’ wages. In addition, employers must also pay their own employer FICA taxes and report both these and their employees’ portions to the IRS. FICA taxes are the most important tax to stay on top of and get correct. Not withhold or paying the correct amount of FICA taxes will result in serious consequences for the employer. All businesses must report FICA taxes quarterly to the IRS using Form 941.
Limits on FICA Taxes
In 2022, the Social Security pay base is set at $147,000. This implies you’ll pay 6.2 percent of your earnings up to $147,000 in Social Security taxes. Your earnings beyond that threshold will not be taxed for Social Security.
Because the Medicare tax has no earnings ceiling, you must pay the 1.45 percent tax on all of your earnings. You must pay an extra Medicare tax if you file your taxes as a single individual and earn more than $200,000 per year. This tax is determined at 0.9 percent of your earnings exceeding $200,000 per year. If you are married and file jointly, the extra tax will be levied on earnings in excess of $250,000.
Medicare Tax
The Medicare program ensures all Americans 65 years and older have access to federal health insurance. The Medicare tax that you see on your paystub is what supports this program. Both employees and employers must pay Medicare tax. If you are self-employed, you will pay self-employment tax, which is the equivalent of both employee and employer portions of the Medicare Tax.
In 2019, the rate of Medicare tax was 1.45% of an employee’s gross earnings. The employer’s rate matches that rate. If you make more than the threshold set by the IRS, you will have to pay an additional Medicare tax of 0.9%.
Social Security Tax
Social Security tax, like Medicare tax, is designed to help support the millions of retired Americans. This tax pays for federal disability and retirement benefits. Both employers and employees must pay Social Security Tax. As with Medicare tax, self-employed individuals will have to pay both the employee and employer portion of Social Security Tax.
The rate for Social Security tax in 2019 was 6.2% of an employee’s gross wages below $132,900. The employer must match the amount paid by the employee. If an employee makes more than the set $132,900, Social Security tax should not be withheld from their pay for any earnings made above this amount.
If you do not follow Social Security, Medicare, or FICA instructions carefully, you may end up either not deducting enough or too much. This is especially true if you continue to deduct taxes from earnings made over the set threshold. In this case, the money will have to be refunded to your employees. This is easily avoidable if you have a streamlined process for your taxes and payroll systems. Check out our pay stub generator to help you with your taxes. Our pay stub generator accurately calculates and deducts taxes based on the information you provided and the state in which you live. Try it now and see for yourself.
How the Social Security Tax Functions
Employees and self-employed taxpayers are subject to the Social Security tax. Employers often deduct this tax from employees’ wages and remit it to the government. The monies received from employees for Social Security are not held in trust for the specific employee who is now contributing to the fund, but are instead utilized to pay existing older persons under a “pay-as-you-go” system.
Social Security taxes are also collected to assist those who are entitled to survivorship benefits, which are payments made to a surviving spouse after the death of a spouse or to a dependent child after the death of a parent.
As of 2021, the Social Security tax rate is 12.4 percent. 6.2 % is paid by the employer, with the employee responsible for the other 6.2%. The Social Security tax rate is applied to all sorts of employee income, including salaries, wages, and bonuses. There is, however, an income cap over which the tax rate is imposed. For 2021, the Social Security tax is deducted from earnings up to an annual maximum of $142,800; earnings over this level are exempt.
Social Security Taxes as an Example
The Social Security tax is a regressive tax, which means that a bigger share of the total income of lower-income workers is withheld than that of higher-income earners. Consider Izzy and Jacob, two workers. For the tax year 2020, Izzy earns $85,000 and has a 6.2 percent Social Security tax taken from his wages. In effect, the federal government takes 6.2 percent x $85,000 = $5,270 from Izzy to help pay for retirement and disability payments.
In contrast, Jacob makes $175,000 in tax year 2020. The Social Security tax rate will only be applied up to the $137,700 limit (the Social Security tax limit for 2020 is $137,700; the ceiling increases to $142,800 in 2021). 9 As a result, Jacob will contribute 6.2 percent x $137,700 = $8,537.40 to the country’s Social Security account for the elderly and disabled, but his effective Social Security tax rate is $8,537.40 $175,000 = 4.87 percent. With a reduced annual income, Izzy is effectively taxed at 6.2 percent (i.e., $5,270 – $85,000).
Even if a household earns enough to avoid paying federal income tax, the Social Security tax may still be deducted from their wages. A single taxpayer earning $10,000 in gross income in a given year, for example, will owe no income tax, but 6.2 percent may be deducted for Social Security.
