As a small business owner, you’re required to pay different taxes to the federal government. To make sure that you stay away from legal trouble, it’s important that you’re aware of the different types of tax liabilities you face and what you need to do to stay in compliance.
The Federal Insurance Contributions Act (FICA) is a federal income tax and one of several payroll taxes that the government charges. It is used to fund Social Security and Medicare benefits, which help people retire and find health insurance and hospital insurance. One reason it can be difficult to understand FICA is that it’s split between employers and employees and has different rules for high-income earners than for other workers.
This article will explain what FICA taxes are, why they’re important, and how you can calculate them for a given year.
What Is FICA?
The FICA is a payroll tax withholding from a worker’s gross income that is also paid by their employer. The government uses it to pay for Social Security retirement benefits and Medicare programs. Paying FICA taxes is unavoidable, and it also provides aid to those who are widowed, orphaned, or have disabilities.
Generally, an employer will withhold half an employee’s FICA tax from their paycheck and pay the other half themselves. And while employees can’t deduct FICA taxes on their tax returns, they can deduct the amount from which FICA taxes were deducted. Sometimes, these taxes can show up under a different name on an employee’s paychecks. For example, Old-Age, Survivors, and Disability Insurance (OASDI) is another name for Social Security.
Periodically, employers must send FICA tax deposits to the IRS using the Electronic Federal Tax Payments System (EFTPS). Between deposits, employers keep the employee portion of FICA taxes in a trust fund. Every quarter, employers must send Form 941 to the IRS, notifying them of employee tax withholdings and the amount the employers have paid. The form has to be in on the final day of the month after a quarter ends. If your company’s second quarter ends in June, the report will be due July 31.
How Is FICA Calculated?
These are two different FICA tax rates: Social Security tax and Medicare tax. They are taxed on workers’ gross wages. The portion that goes to pay for Social Security benefits is equal to 12.4% of an employee’s total gross income. The portion that goes to pay for Medicare benefits is equal to 2.9% of an employee’s total gross income. This means that the total amount of FICA taxes owed for each employee is 15.3% of their total gross earnings (under normal circumstances).
These percentages are set by the government and can change periodically. However, they have stayed the same for a few years and are likely to remain so in 2021, in part due to the coronavirus pandemic that has wreaked havoc on the economy, making it difficult for many businesses to make tax payments.
For example, let’s say your employee makes $20,000 a year. Their FICA tax would total $3,060: $2,480 for Social Security tax and $580 for Medicare tax. However, only half of that amount ($1,530) will be paid through the employee’s wages (7.65% of their gross income). The other half is covered by the employer portion. Self-employed people technically pay Self-Employed Contributions Act (SECA) taxes and are on the hook for the full 15.3% in self-employment tax.
(Total Income * 0.124) + (Total Income * 0.029) = FICA
Social Security Medicare Total FICA Tax
The portion of FICA taxes that an employer pays doesn’t increase an employee’s taxable income. For example, if you make $30,000 in a year working for a corporation, you’ll end up paying $2,295 in FICA taxes. Your company will also pay $2,295 on your behalf. Even though the company is making a payment on your behalf, your taxable income will remain $30,000 and not $32,295.
For high earners, the formula is more complex. There’s a limit to how much Social Security tax workers have to pay. A "wage base" is the maximum amount of income that the government can charge Social Security tax on. The wage base is set by the government and can change from year to year. In 2019, it was $132,900. In 2020, it rose to $137,700. This means that any income an employee makes after $137,700 will not be subject to Social Security taxes.
On the contrary, high earners will have to pay extra Medicare tax. Although Medicare does make up a much smaller portion of an employee’s income. High-paid workers have to pay an additional 0.9% in Medicare taxes past a certain amount of earned income in a calendar year. The amount varies depending on their filing status:
- $250,000/year if married and filing jointly
- $125,000/year if married and filing separately
- $200,000/year if single or a widow/widower
For example, let’s say you have a single employee who makes $210,000 a year. They’ll owe a 12.4% Social Security tax on the wage base of $137,700 ($17,074.80). They’ll also owe a 2.9% Medicare tax on $200,000 ($5,800). However, on the $10,000 beyond the first $200,000, they’ll owe an additional 0.9% Medicare tax. This makes the total owed on the employee’s last $10,000 of income 3.8% (2.9% + 0.9%), which would be $380. Employers don’t have to match the additional 0.9% Medicare taxes. The total amount in FICO taxes that would be due on the employee’s behalf would be $23,254.80.
(137,700 * 0.124) + (200,000 * 0.029) + (10,000 * 0.038) = FICA
Social Security Medicare Bonus Medicare Total FICA Tax
Keep in mind that the employer would pay half of the employee’s FICA taxes, excluding the extra Medicare tax for the high salary. In the above situation, the employer would pay $11,437.40, while the remaining $11,817.40 (the amount the employee would see on a W-4) would be withheld from the employee’s paycheck over the course of the year.
What’s Not Subjected to FICA Tax
For the most part, FICA taxes are inevitable. The percentage of earned income an employee has to pay in FICA taxes is generally stagnant. Although there are a few types of income that are exempt from FICA taxes. To qualify for these exemptions, a worker must meet some strict requirements. Some exemptions that can exclude income from being taxed for FICA include the following:
- Income paid after an employee has died
- Income for a disabled worker who is eligible for Social Security disability insurance
- Workers’ compensation for injured workers
- Employer payments to employee retirement plans
Students also don’t have to pay FICA taxes if they work for a school in which they’re currently enrolled. This can help students who may struggle to pay for their education. However, i t’s important to note that the student must work for their particular school. For example, income earned from a job waiting tables at a nearby restaurant would still be charged FICA taxes. If you think you may qualify for an exemption in paying FICA taxes, visit the IRS website.
Take the Complexity Out of Accounting with Skynova
In addition to FICA taxes, there’s a wide array of other payroll taxes that businesses in the United States must pay attention to every pay period. It can be difficult to keep track of your tax liability, especially when dealing with federal taxes as confusing as FICA.
Skynova has a wide selection of software that can help simplify your business’s accounting process. We even have cloud-based alternatives to sharing documents with clients that can be valuable during the COVID- 19 pandemic. The chances are that you didn’t get in business to do paperwork. Let us handle your administration so that you can focus on your customers.
In addition to accounting software, we have free business templates for things like invoices, quotes, and estimates. Time is money, and if you’ve been making your own forms from scratch, you’re wasting it.
See what Skynova can do for you. Make your first quality, professional-looking invoice using our template today. You’ll be amazed by how easy your administration can be.