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Federal Insurance Contributions Act

Updated on April 29, 2024
Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Federal Insurance Contributions Act (FICA) Definition

Federal Insurance Contributions Act (FICA) is a federal law requiring employers and employees to pay payroll taxes for funding two crucial federal programs — Medicare and Social Security. Without this act, Social Security benefits would cease to exist, and Americans would not get the benefits offered by Medicare.

Federal Insurance Contributions Act

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The deduction of FICA tax from employees’ paychecks takes place automatically, and the amount is split between the employer and the employee, with each of the parties responsible for making payment of a certain percentage of the overall tax. FICA tax has two components with particular limits and rates determining the contribution required from both parties. 

Key Takeaways

  • Federal Insurance Contributions Act refers to a United States payroll tax that gets deducted from employees’ paychecks to fund the Medicare and Social Security programs. 
  • Employees, as well as their employers, pay FICA taxes. Note that the federal government keeps altering the tax rates and associated limits to accommodate the alterations taking place in the country’s population.  
  • Some groups and individuals do not have to pay FICA taxes. Some examples include non-resident aliens working in the US and religious groups establishing a religious objection to getting benefits of Medicare or Social Security. 

Federal Insurance Contributions Act Explained

Federal Insurance Contributions Act refers to a United States law introduced in 1935 that mandates employees to pay a specific percentage of their income toward Medicare and Social Security programs. Their employers match that percentage, paying into those two programs. This act aims to accumulate enough funds to ensure that the Medicare and Social Security programs continue running. 

For salaried individuals, the percentage gets withheld from their paycheck by the employer. On the other hand, self-employed persons have the responsibility of making payments of both halves bundled into the same tax amount. Note that this is not covered in the FICA Act. 

The Social Security component of the act comes with a base limit concerning wages. On the other hand, the Medicare component does not come with such a limit. The meaning of wage base limit refers to the income from which the employer can withhold taxes

History

Former U.S. President, Franklin D. Roosevelt introduced this federal law in 1935. The purpose of this act was to reduce the government’s burden of making payments for the benefits offered by the Social Security program. 

Roosevelt intended to establish a system that could fund itself. Moreover, he believed that the funds accumulated from working Americans via the Federal Insurance Contributions Act of 1935 would directly belong to them. Roosevelt did not want all the financial benefits for their disability, death, and retirement to depend on government revenue. This is because he feared that politicians in the US would utilize the funds from federal revenue to fulfill personal purposes. Roosevelt understood that if the FICA taxes were there, no politician would remove the US Social Security program.

The Medicare component came into existence once former US President Lyndon Johnson introduced Medicare in 1965. Over the years, the base wages, as well as the FICA rates, have been subject to change. The US government makes adjustments to these elements to adapt to the changes taking place in the United States population.

FICA Tax Rates And Limits

Per the Internal Revenue Service (IRS), Federal Insurance Contributions Act taxes comprise disability insurance, old age, and survivors taxes along with hospital insurance tax. Different tax rates apply to each of these two components. 

As noted above, a maximum wage base exists for social security tax on income. No tax is levied on any amount above that level. The wage base was $160,200 for 2023. That said, it is $168,600 for 2024. 

As mentioned earlier, a wage base limit does not exist for Medicare taxes. 

The overall social security tax rate for 2023 and 2024 is 12.4%; it is split between employer and employee. In other words, the employer has to pay 6.2%, and the employee also needs to pay 6.2%. Note that the overall Medicare tax rate is also split between employer and employee. Each of them pays 1.45%, which makes the total rate 2.9%.  

Note that employees make payments of an extra 0.9% Medicare taxes on income above a threshold. The amount is $200,000 for individuals and $250,000 for any married couple filing taxes jointly. Hence, depending on the wages, employees’ overall Medicare tax rate can increase to 2.35%, i.e., 1.45% + 0.9%. Note that employers do not need to match the extra Medicare tax rate of 0.9%.

Examples 

Let us look at a few Federal Insurance Contributions Act examples to understand the concept better.

Example #1

Suppose an employee named David, who earned $40,000, had to pay a total of $3,060 in Federal Insurance Contributions Act contributions for 2023. The amount comprised $28,800 in Social Security taxes and Medicare taxes worth $580. David’s employer, Company ABC, had to pay the exact amount. 

Let us look at the calculation. 

  • Social Security tax paid = $40,000 x 0.062, i.e., $2,480
  • Medicare tax paid = $40,000 x 0.0145 =$580
  • Therefore, overall FICA contribution = $2,480 + $580, i.e., $3,060.

Example #2

In June 2023, the Internal Revenue Service released Office of Chief Counsel or OCC Memorandum 202323006. It advised that all wellness indemnity payments falling under fixed indemnity insurance policies are wages or income for purposes of employment taxes if employees do not have any unreimbursed medical expenses associated with the payments. Such employment taxes include FICA taxes, federal income tax withholding (FITW), and Federal Unemployment Tax Act (FUTA) taxes. 

The memo drafted by the Internal Revenue Service OCC offers guidance concerning programs that are marketed to different employers who purport to decrease FICA obligations by a significant margin. Note that such OCC memos are neither regulations nor laws. They offer authoritative legal advice to Internal Revenue Service personnel to provide them with assistance regarding industry-wide problems. 

FICA Tax Exemptions

There are specific groups and individuals exempt from paying FICA taxes. Moreover, there are specific considerations for a self-employed individual. 

#1 – Exempt Groups And Individuals 

  • Religious Exemptions – Specific religious groups’ members, for example, Amish communities, can be exempt from FICA tax payments if they establish any religious objections to getting Social Security or Medicare benefits. 
  • Non-Resident Aliens – Generally, non-resident aliens who work in the US are exempt from these payroll taxes. However, there are certain exceptions. For example, a non-resident alien who is an employee of international organizations or foreign governments must pay taxes per the Foreign Insurance Contributions Act of 1935.
  • Students, As Well AS Other Specific Groups – Students who work for the institute they study in can be exempt from such payroll taxes if the employment is part of the entity’s work-study program. Also, exemption may be available if the work carried out by a student is incidental to the educational pursuits. In addition, other specific groups, for example, particular foreign agricultural workers, may not have to pay FICA taxes. 

#2 – Self-Employed Individuals 

Self-employed persons do not have to pay FICA taxes. Rather, they must make payment of self-employment tax. This tax funds both Medicare and Social Security. Note that the tax rate of the self-employment tax is 15.3%, which means it is the same as the FICA employer and employee tax rates combined 

Self-employed individuals compute and make payments of self-employment tax utilizing Form 1040 and Schedule SE. The federal government mandates the calculation of the tax based on a taxpayer’s net income generated from self-employment, which is subject to the exact wage-related thresholds as the FICA taxes. 

Taxpayers require Schedule SE to compute their self-employment tax liability. They utilize Form 1040 to report the tax to the government and pay it. Self-employed persons must report their income in Schedule C or F of Form 1040 based on their business activities’ nature. 

Frequently Asked Questions (FAQs) 

How do I check my Federal Insurance Contributions Act tax refund online?

Individuals must note that no option allows them to check the status of their FICA tax refund online. They can call the Internal Revenue Service at 267-941-1000 and get information regarding the status of the tax refund.

How do I claim a Federal Insurance Contributions Act tax refund?

If individuals paid FICA tax but they were exempt from paying the same, they are eligible for a tax refund. Note that the fastest way of getting the refund is via the employer. However, if that is not possible, the federal tax agency, i.e., the IRS, can issue the same.

What is the difference between the Federal Insurance Contributions Act tax and federal income tax?

FICA tax is a payroll tax automatically deducted from an employer’s salary. It funds Medicare and Social Security Programs. On the other hand, federal income tax does not get automatically deducted from an employee’s paycheck. Moreover, the government levies income tax to support a range of services, including national defense, public assistance programs, healthcare, etc.

This article has been a guide to the Federal Insurance Contributions Act & its definition. We explain its history, tax rates, limits, examples, & tax exemptions. You may also find some useful articles here –

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