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Federal Insurance Contributions Act tax

The 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, disabled people, 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 cannot afford healthcare treatment. Because the tax falls exclusively on wages and not on physical or financial capital, payroll taxes may lead to underinvestment in human capital such as higher education.[3] 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.[4] This has caused some to claim that the payroll tax is not a tax because its collection is directly tied to benefits that one is entitled to collect later in life.[5] 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.[6]

In the United States, the term payroll tax usually refers to the FICA tax; income tax refers to other federal and state employment taxes.

Contents

CalculationEdit

OverviewEdit

 
Share of federal revenue from different tax sources. Individual income taxes (blue), payroll taxes/FICA (green), corporate income taxes (red).[7]

The Center on Budget and Policy Priorities states that three-quarters of taxpayers pay more in payroll taxes than they do in income taxes.[8] The FICA tax is considered a regressive tax on income with no standard deduction or personal exemption deduction. The Social Security portion of the tax is imposed on only the first $113,700 of gross wages in 2013, $117,000 in 2014, and $118,500 in 2015 and 2016.[9] The FICA tax is not imposed on investment income such as rental income, interest, or dividends.

Regularly employed peopleEdit

Since 2013, the employee's share of the Social Security portion of the FICA tax has been 6.2% of gross compensation up to a limit that adjusts with inflation. The taxation limit in 2014 was $117,000 of gross compensation, resulting in a maximum Social Security tax for 2014 of $7,254.[10] 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.[11] 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.[12] Because some payroll compensation may be subject to federal and state income tax withholding in addition to Social Security tax withholding and Medicare tax withholding, the Social Security and Medicare taxes often account for only a portion of the total an employee pays.

The employer is also liable for 6.2% Social Security and 1.45% Medicare taxes,[13] 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; 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 peopleEdit

 
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.[15]

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.[16][17]

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.[citation needed]

ExemptionsEdit

Exemption for some full-time studentsEdit

Some student workers are exempt from FICA tax. 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.[18] 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.[19] However full-time college students are never exempt from FICA taxes on work performed off-campus.[19]

Medical residents working full-time are not considered students and are not exempt from FICA payroll taxes, according to a United States Supreme Court ruling in 2011.[19]

Exemption for employees of some state governments and local governmentsEdit

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.[20]

Exemption for some nonresident aliensEdit

Some nonresident aliens are exempt from FICA tax.

  • Nonresident aliens who are employees of foreign governments are exempt from FICA on wages paid in their official capacities as foreign government employees.[21]
  • Nonresident aliens who are employed by a foreign employer as a crew member are exempt from FICA on wages paid for working on a foreign ship or foreign aircraft.[21]
  • Nonresident aliens who are students, scholars, professors, teachers, trainees, researchers, physicians, au pairs, or summer camp workers and are temporarily in the United States in F-1, J-1, M-1, Q-1, or Q-2 nonimmigrant status are exempt from FICA on wages paid to them for services that are allowed by their visa status and are performed to carry out the purposes the visa status.[21]
  • Nonresident aliens who are employees of international organizations are exempt from FICA on wages paid by international organizations.[21]
  • Nonresident aliens who are on an H-2A, H-2B, or H-2R visa and are residents of the Philippines are exempt from FICA on wages paid for work performed in Guam.[21]
  • Nonresident aliens who are on an H-2A visa are exempt from FICA.[21]

Exemption for members of some religious groupsEdit

Members of certain religious groups, such as the Mennonites and the Amish, may apply to be exempt from paying FICA tax.[22][23] These religious groups consider insurance to be a lack of trust in God; the religious groups believe it is their religious duty to provide for its members who are sick, disabled, and elderly.[24]

In order to apply to become exempt from paying FICA tax under this provision, the person must file Form 4029, which certifies that the person:[25]

People who claim the above exemption must agree to notify the Internal Revenue Service within 60 days of either leaving the religious group or no longer following the established teachings of the religious group.[23]

Exemption for some aliens on temporary work assignmentEdit

When a person temporarily works outside their country of origin, the person may be covered under two different countries' social security programs for the same work.[26] In order to relieve a person of double-taxation, the certain countries and the United States have entered into tax treaties.[26]

Aliens whose employer sends them to the United States on a temporary work assignment may be exempt from paying FICA tax on their earnings from working in the United States if there is a tax treaty between the United States and the worker's home country.[26] Countries who have such a tax treaty with the United States include Australia,[27] Austria,[28] Belgium,[29] Canada,[30] Chile,[31] Czech Republic,[32] Denmark,[33] Finland,[34] France,[35] Germany,[36] Greece,[37] Hungary, [38] Ireland,[39] Japan,[40] Luxembourg,[41] Netherlands,[42] Norway,[43] Poland,[44] Portugal,[45] Slovakia,[46] South Korea,[47] Spain,[48] Sweden,[49] Switzerland,[50] and United Kingdom.[51]

In order to claim an exemption from paying FICA tax, the alien worker must be on a temporary assignment of no more than five years and the alien worker must have a certificate from the country stating that the worker will continue to be covered by the country's social security system while the worker is in the United States.[26]

Exemption for some family employeesEdit

When a parent employs a child under age 18 (or under age 21 for domestic service), payments to the child are exempt from FICA tax.[52] The exemption also applies when a child is employed by a partnership in which each partner is a parent of the child.[52] The exemption does not apply when the child is employed by a corporation or a partnership with partners who are not the child's parent.[52]

Exemption for foreign governments and some international organizationsEdit

Foreign governments and are exempt from FICA tax on payments to their employees.[53] International organizations are also exempt if the organization is listed in the International Organizations Immunities Act.[54][55]

If an employee is either a U.S. citizen, then the employee must typically pay self-employment tax on earnings from work performed in the United States.[55]

Exemption for certain emergency workersEdit

If a state or local government's employees were hired on a temporary basis in response to a specific unforeseen fire, storm, snow, earthquake, flood, or a similar emergency, and the employee is not intended to become a permanent employee, then payments to that employee are exempt from FICA tax.[56]

Exemption for certain newspaper carriersEdit

Payments to newspaper carriers under age 18 are exempt from FICA tax.[57]

Exemption for some real estate agents and salespeopleEdit

Compensation for real estate agents and salespeople is exempt from FICA tax under certain circumstances.[58][59] The compensation is exempt if substantially all compensation is directly related to sales or other output, rather than to the number of hours worked, and there is a written contract stating that the individuals will not be treated as employees for federal tax purposes.[58][59] The individual must typically pay self-employment tax on the compensation.[58][59]

HistoryEdit

Prior to the Great Depression, the following presented difficulties for Americans: [60]

  • 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.[61]

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. [62]

CriticismEdit

The Social Security component of the FICA tax is regressive. That is, the effective tax rate regresses, or decreases, as income increases beyond the compensation limit or wage base limit amount.[63] The Social Security component is a flat tax for wage levels under the Social Security Wage Base (see "Regular" employees above). Because no tax is owed on wages above the wage base limit amount, 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.

The earnings above the wage base limit amount are not, however, taken into account in the Primary Insurance Amount (PIA) to determine benefits payable under the various insurance programs of social security.[citation needed]

The FICA tax also is not imposed 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 that 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; but for some lower earners, shorter lifetimes may negate the benefits.[64][65][66]

See alsoEdit

ReferencesEdit

  1. ^ The FICA tax is imposed under the Federal Insurance Contributions Act, which is codified as I.R.C. ch. 21
  2. ^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 367. ISBN 0-13-063085-3. 
  3. ^ "The Knowledge Tax". University of Chicago Law Review. 82: 1981. 2015. 
  4. ^ "Policy Basics: Federal Payroll Taxes". Center on Budget and Policy Priorities. April 15, 2013. Retrieved November 17, 2013. 
  5. ^ Kevin A. Hassett, March 29, 2005, "Is the Payroll Tax a Tax?" National Review Online, at nationalreview.com
  6. ^ CHAPTER 21—Federal Insurance Contributions Act from the Legal Information Institute at Cornell Law School
  7. ^ JCX-49-11, Joint Committee on Taxation, September 22, 2011, pp 4, 50.
  8. ^ 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
  9. ^ Social Security Administration Update
  10. ^ U.S. Social Security Administration, at ssa.gov
  11. ^ IRS Publication 15 (2011)
  12. ^ Revenue Code Section 3101. Tax Almanac.
  13. ^ Internal Revenue Code Section 3111. Tax Almanac.
  14. ^ "OASDI and SSI Program Rates & Limits, 2014". Ssa.gov. Retrieved 2014-04-15. 
  15. ^ Table T11-0099, Effective Federal Tax Rates Under Current Law, By Total Income Percentile, 2010, Tax Policy Center.
  16. ^ I am self-employed. How do I pay Social Security tax?. Social Security Administration. Retrieved on April 28, 2007.
  17. ^ Self-Employment Tax. Internal Revenue Service. Retrieved on April 28, 2007.
  18. ^ Rev. Proc. 2005-11 (pdf). Internal Revenue Service. April 1, 2005. p. 5.
  19. ^ a b c Mayo Foundation for Medical Education and Research Et Al. v. United States (pdf). Supreme Court of the United States. January 11, 2011.
  20. ^ Miller, Girard. "The FICA Free-Lunch Crowd". Governing. August 12, 2010.
  21. ^ a b c d e f "Social Security/Medicare and Self-Employment Tax Liability of Foreign Students, Scholars, Teachers, Researchers, and Trainees". Internal Revenue Service. August 23, 2016. Retrieved May 12, 2017.
  22. ^ a b c d e "Are members of religious groups exempt from paying Social Security taxes?" Social Security Administration. January 9, 2017.   This article incorporates text from this source, which is in the public domain.
  23. ^ a b "Form 4029: Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits". Internal Revenue Service. September 2014.
  24. ^ Green, Parman R. "Taxation Tidbit The Amish – Social Security and Medicare Taxes". University of Missouri. Retrieved May 12, 2017.
  25. ^ "RS 01802.273 Method of Obtaining Exemption — Process". Social Security Administration. April 2006.
  26. ^ a b c d "International Agreements: U.S. International Social Security Agreements". Social Security Administration. Retrieved May 12, 2017.
  27. ^ "Totalization Agreement with Australia". Social Security Administration. January 2004.
  28. ^ "Totalization Agreement with Austria". Social Security Administration. May 2005.
  29. ^ "Totalization Agreement with Belgium". Social Security Administration. January 2004.
  30. ^ "Totalization Agreement with Canada". Social Security Administration. January 2004.
  31. ^ "Totalization Agreement with Chile". Social Security Administration. October 2013.
  32. ^ "Totalization Agreement with the Czech Republic". Social Security Administration. February 2009.
  33. ^ "Totalization Agreement with Denmark". Social Security Administration. October 2008.
  34. ^ "Totalization Agreement with Finland". Social Security Administration. July 2008.
  35. ^ "Totalization Agreement with France". Social Security Administration. May 2012.
  36. ^ "Totalization Agreement with Germany". Social Security Administration. May 2005.
  37. ^ "Totalization Agreement with Greece". Social Security Administration. September 2008.
  38. ^ "U.S.-Hungary Social Security Agreement". Social Security Administration. February 3, 2015.
  39. ^ "Totalization Agreement with Ireland". Social Security Administration. July 2005.
  40. ^ "Totalization Agreement with Japan". Social Security Administration. August 2005.
  41. ^ "Totalization Agreement with Luxembourg". Social Security Administration. January 2005.
  42. ^ "Totalization Agreement with the Netherlands". Social Security Administration. March 2011.
  43. ^ "Totalization Agreement with Norway". Social Security Administration. January 2004.
  44. ^ "Totalization Agreement with Poland". Social Security Administration. March 2011.
  45. ^ "Totalization Agreement with Portugal". Social Security Administration. May 2009.
  46. ^ "U.S.-Slovak Social Security Agreement". Social Security Administration. December 10, 2012.
  47. ^ "Totalization Agreement with Korea". Social Security Administration. January 2004.
  48. ^ "Totalization Agreement with Spain". Social Security Administration. November 2005.
  49. ^ "Totalization Agreement with Sweden". Social Security Administration. July 2007.
  50. ^ "Totalization Agreement with Switzerland". Social Security Administration. April 2005.
  51. ^ "Totalization Agreement with the United Kingdom". Social Security Administration. May 2005.
  52. ^ a b c "Publication 15: (Circular E), Employer's Tax Guide". Internal Revenue Service. 2017. p. 12–13.
  53. ^ "Publication 15: (Circular E), Employer's Tax Guide". Internal Revenue Service. 2017. p. 37.
  54. ^ 22 U.S.C. 288-288f.
  55. ^ a b "Persons Employed by a Foreign Government or International Organization - Federal Insurance Contributions Act (FICA)". Internal Revenue Service. October 31, 2016.
  56. ^ "Publication 15: (Circular E), Employer's Tax Guide". Internal Revenue Service. 2017. p. 38.
  57. ^ "Publication 15: (Circular E), Employer's Tax Guide". Internal Revenue Service. 2017. p. 39.
  58. ^ a b c "Publication 15: (Circular E), Employer's Tax Guide". Internal Revenue Service. 2017. p. 40.
  59. ^ a b c "Publication 15-A: Employer's Supplemental Tax Guide". Internal Revenue Service. 2017. p. 6–7.
  60. ^ Historical Background and Development of Social Security Social Security Administration
  61. ^ "Congress passes extension of payroll tax cut, unemployment benefits". CBS News. 
  62. ^ UNITED STATES v. QUALITY STORES, INC. et al. by the Supreme Court of the United States, retrieved May 2, 2014
  63. ^ Social Security Snares & Delusions by Irwin Stelzer, The Weekly Standard. Retrieved July 23, 2008
  64. ^ Is Social Security Progressive? by the Congressional Budget Office, retrieved July 23, 2008
  65. ^ 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. 
  66. ^ "Are Social Security taxes regressive?". The Economist. April 14, 2009. Retrieved March 24, 2012. 

External linksEdit