Federal Insurance Contributions Act tax

The Federal Insurance Contributions Act (FICA) tax is a United States payroll (or employment) tax^[1] imposed by the federal government on both employees and employers to fund Social Security and Medicare—federal programs that provide benefits for retirees, the disabled, and children of deceased workers. Social Security benefits include old-age, survivors, and disability insurance (OASDI); Medicare provides hospital insurance benefits.

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How the tax is calculated

Overview

The Center on Budget and Policy Priorities states that three-fourths of taxpayers pay more in payroll taxes than they do in income taxes.^[2] The FICA tax is considered a regressive tax on income (with no standard deduction or personal exemption deduction) and is imposed (for the year 2008) only on the first $102,000 of gross wages. The tax is not imposed on investment income (such as interest and dividends).

"Regular" employees (most wage-earners)

For 2008, the employee's share of the Social Security portion of the tax is 6.2% of gross compensation up to a limit of $102,000 of compensation. 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). The employee's share of the Medicare portion is 1.45% of wages with no limit. The employer is also liable for separate 6.2% and 1.45% Social Security and Medicare taxes, respectively, making the total Social Security tax 12.4% and the total Medicare tax 2.9% of wages. (Self-employed people are responsible for the entire FICA percentage of 15.3% (= 12.4% + 2.9%), since they are 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 has already earned the wage base limit for Social Security, the new employer is not allowed to stop withholding it until the wage base limit has been earned with them. There are some cases, such as a successor-predecessor 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 will get a refund when they file their Federal income tax return.

Self-employed people

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 simpler words, it makes the calculation fair because employees don't get taxed on their employers' contribution of the second half of FICA, therefore self-employed people shouldn't 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). Again, this evens the playing field for self-employed persons in comparison to regular employees, who don't pay general income tax on their employers' contribution of the second half of FICA, just as they didn't pay FICA tax on it either.^[3][4]

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,^[5], 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

A special case in FICA regulations includes exemptions for student workers. Students enrolled full-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.

History

Prior to the Great Depression, these economic problems were great hazards to working-class Americans:

• The U.S. had no federal-government-mandated retirement savings; consequently, for many workers, 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—work-related or 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.
• Finally, the U.S. had no federal-government-mandated health insurance for the elderly; consequently, for many workers, 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.

Criticism

Role of government

The FICA tax funds social services that are generally considered a safety net for disabled people and retired people. The tax forces citizens to do two things that many people often choose not to do for themselves until too late: buy insurance against risks and save for retirement. The lack of insurance and retirement money would have little effect on some people (that is, relatively wealthy people, or non-wealthy people who remained non-disabled throughout their working careers, then died soon after retirement). However, the lack of insurance and retirement money would predictably lead to poverty among many other people (that is, non-wealthy people who suffered disability, or non-wealthy people who remained non-disabled throughout their working careers, then lived many years after retirement).

One critique of the system is that working people are forced to contribute to these services—that these services should not be mandated by law, and that the wisdom of using authority of government to force the funding of such programs is debatable. If left to their own devices, some people would fail to buy adequate insurance or save for retirement. Although this would lead to poverty among some fraction of the population, critics argue that the ideal of individual freedom allows one to make such choices.

Other critics do not question that the government should mandate the existence of compulsory insurance and retirement savings, but they don't agree that the government itself should run the programs. They argue that the government should simply supply the mandate and let commercial institutions supply the services, allowing the advantages of markets to operate. An analogy is automobile insurance; although some states mandate that drivers have automobile insurance, the state government itself is not the insurance company. Commercial companies supply the service, compete with each other, and are motivated by profit. This method is considered preferable, by some free market advocates, under the theory that competition and profit, as market forces, motivate companies to operate properly and efficiently. Some Americans, therefore, feel that the Social Security and Medicare programs could benefit from following the model of 'government-mandates-but-industry-supplies'. Per this argument, the programs could be implemented by continued collection of the FICA tax, but also of giving workers choices about which insurance company and investment methods they use.

Recent debates in Congress center on citizens' choice of where to invest their social security funds, as government returns on the levied investment yield much smaller returns than would be gained by allowing their select investment in the private market. Some people contend that putting such crucial public programs in private hands would make said public programs vulnerable to the greed and whims of private entrepreneurs. In this argument, an entrepreneur who finds the citizen-consumer's interest conflicting with his-her own corporate profit may sacrifice the public interest in favor of private profit.

Regressive

The Social Security component of the FICA tax is generally considered regressive, meaning the effective tax rate regresses (decreases) as income increases. The Social Security component is actually a flat tax for wage levels under the Social Security Wage Base (see "Regular" employees above). But since no tax is owed on wages above the Wage Base limit, the tax rate effectively 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; since this number (the numerator) remains constant while the denominator (the wage level) increases, the effective tax rate steadily decreases as wage levels increase beyond the Wage Base limit.

Some critics contest this classification.^{[citation needed]} They argue that since Social Security benefits are eventually returned to taxpayers, with interest, in the form of Social Security benefits, the regressiveness of the tax is effectively negated—i.e., the taxpayer gets back what he or she put into the Social Security system. Furthermore, Social Security benefits are returned "progressively"—i.e., individuals with lower lifetime average wages receive a larger benefit (as a percentage of their lifetime average wage income) than do individuals with higher lifetime average wages. This means that, in the view of the critics, the net effect of the Social Security system is progressive.^{[citation needed]} A counter-argument to this criticism is that the criticism assumes that every individual will live long enough (or be disabled long enough) to receive a complete return of his or her Social Security contributions. If a large proportion do not, then a large portion of the tax remains unreturned, and the tax remains regressive.^{[citation needed]}

In addition, for very low income individuals with no children, the Earned Income Tax Credit operates as an effective refund of FICA taxes, since the amount of the credit is calculated to be congruent with the amount withheld from the individual's wages, up to a certain level. The credit phases out and disappears altogether at higher wage levels.

See also

• Cafeteria plan
• FairTax — Proposal to replace FICA taxes
• Form W-2
• Income tax
• National Insurance contribution (NIC), a similar tax in the United Kingdom
• FICO, a similar-sounding acronym in the world of personal finance that people sometimes confound with FICA

References

1. ^ The FICA tax is imposed under the Federal Insurance Contributions Act, which is codified as 26 U.S.C. ch.21
2. ^ 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
3. ^ I am self-employed. How do I pay Social Security tax?. Social Security Administration. Retrieved on April 28, 2007.
4. ^ Self-Employment Tax. Internal Revenue Service. Retrieved on April 28, 2007.
5. ^ http://answers.google.com/answers/threadview?id=493077 A discussion in which self-employed people helped each other make sense of the tax universe