There are many types of taxes from federal, state, sales, property, and FICA taxes which gives the government many sources of revenue. However, all these taxes pay for different items like property taxes being used to fund public schools. One main type of tax every taxpayer pays is called the Federal Insurance Contributions Act or FICA tax.
This tax is also referred to as the payroll tax and funds two main public insurance programs:
- Medicare: provides healthcare for seniors over 65
- Social Security: allows people to receive a monthly source of income or pension when they retire.
History of FICA tax and different variations
The concept of a social insurance program has been around since the Civil War. There was a primitive version during the Civil War era (the 1860’s), but it eventually died off. This happened because the country was dealing with more important issues at the time like reunifying the USA.
However, the current version of the FICA tax was created by President Franklin Roosevelt during the great depression. Times were tough, with massive unemployment and poverty among the elderly. Therefore, Roosevelt decided that a public insurance program was needed to protect US citizens, especially seniors, from poverty and signed the Social Security Act in 1935.
In the 1970s, Medicare was created to provide health care to citizens and Social Security was expanded to provide a pension for disabled workers under 65. Currently, qualified disabled individuals and beneficiaries can receive social security payments even if they’re under 65. Since the signing of the Social Security Act, every working citizen has been required to pay a percentage of their pay to fund these programs.
Employees must pay 7.65% of their wages as FICA tax to fund Medicare (1.45%) and Social Security (6.2%). The Medicare percentage applies to all earned wages, while the Social Security percentage applies to the first $132,900 of earnings, also known as the Social Security wage base.
Therefore, the maximum Social Security tax for an employee or an employer is $8,239 per year. If an employee switches jobs, he or she will only have to pay up to this cap. If multiple employers withhold more than $8,239 from an employee’s paycheck, that employee can file the excess amount as a credit against taxable income.
Besides the FICA tax, there are different types of related taxes called FUTA and SUTA which are simply unemployment taxes. Employers are required to pay these taxes, which provide unemployment compensation to laid-off employees.
FUTA & SUTA
The FUTA and SUTA taxes are filed on Form 940 each year, regardless if a business has an employee on unemployment insurance. The FUTA tax rate is a flat 6% but is reduced to just 0.6% if it’s paid on time. However, Virgin island employers must pay 2.4% to the government since this territory owes the US government money. FUTA taxes are assessed on the first $7,000 of an employee’s wages as well.
SUTA isn’t as cut and dry as the FUTA as it varies by state. Fortunately, most employers pay little SUTA tax if they haven’t had employees file unemployment claims. Businesses usually file these taxes through their state anytime between October and December. A typical SUTA rate ranges from 2-4%.
Unlike Social Security and Medicare, employees don’t share this tax liability with their employers. Also, employers should be aware of certain occasions that require them to pay FUTA and SUTA. These occasions include:
- Paying employees at least $1,500 during a current or previous calendar quarter.
- Employing a worker for at least part of the day during 20 or more weeks throughout the year. This also applies to the previous year as well.
- If the employees are categorized as “W2” employees. These employees could be full-time, part-time, or seasonal employees. It’s important to note that employers don’t have to pay unemployment taxes for contractors or “1099ers.”
FUTA and especially SUTA taxes can be fairly complex, which is why it’s imperative to contact the proper agency for assistance. It’s especially important to contact the specific state’s unemployment agency since each one has its own distinct policies.
Luckily, these taxes are much smaller than standard taxes and FICA tax. While these taxes do impact businesses, there are 4 simple ways to minimize these tax burdens:
1. File on time
All government agencies reward punctuality. A business can pay these taxes per quarter or annually, as long as it’s consistent. In fact, government agencies assess late fees that range from 2-25%. These fees depend on how late FUTA & SUTA taxes were filed.
2. Minimize employee turnover
Employee turnover is harmful to any business and costs on average $15,000 per person. High turnover lowers morale, increases costs, and causes inefficiency. Low turnover will allow an employer to pay minimal FUTA & SUTA taxes.
3. Promptly respond to each unemployment claim
Again, being prompt is rewarded in this situation. Many businesses that have high employee turnover might not be able to respond promptly. This will not only cause higher taxes but also increase the risk of late fees.
4. Consider automating or outsourcing payroll
Many business owners wear multiple hats and choose to delegate as they grow. One common area to outsource or automate is payroll, with large companies like ADP and Paychex specializing in this. These firms will also help businesses file the proper forms with the correct agency. One type of payroll firm is a Professional employer agency or PEO, which manages multi businesses in a collective . A PEO can also help businesses that have high turnover reduce these taxes by reporting the average turnover of the PEO pod, instead of the individual business.
Check out our roundup of the Best Payroll Services for Small Business
FICA tax and the self-employed
As mentioned above, the tax rates for Medicare and Social Security in 2019 are 1.45% and 6.2% respectively. Self-employed individuals must pay a whopping 15.3%, also known as the self-employment tax. An employer usually pays the other half of the self-employment tax, which is why employees only pay roughly 7% for FICA tax. On the other hand, self-employed individuals don’t have an employer and must pay the entire percentage.
Luckily, the self-employed receive an above the line tax deduction for half of the self-employment tax. It might seem like the self-employed pay more taxes, but they have more available deductions compared to employees. They also have more responsibility as they must pay quarterly payments and be more organized than the average employee.
Additional FICA tax concepts
- Additional Medicare withholding: If a high earner makes more than $200,000 and files single, head of household, or qualifying widow(er); he or she must pay an additional 0.9% Medicare tax on the amount above $200,000. This limit increases to $250,000 for married filing joint taxpayers and decreases to $125,000 for married filing separately taxpayers.
- Pre-tax deductions subject to FICA tax: Certain pre-tax deductions might be exempt from federal and state income taxes, but not FICA tax. 401(k) contributions and adoption assistance deductions are examples of this concept.
- FICA and the Foreign Earned Income Exclusion: US citizens living abroad could exclude up to $105,900 of their income from federal and state taxes if they fulfill certain requirements. One of these requirements includes living outside the USA for at least 330 days out of a full calendar year. However, they can’t exclude this income from FICA tax and must pay the entire self-employment tax.
FICA tax resources
- This is a list of all state unemployment agencies. If an employer has questions regarding the SUTA, it would be wise to inquire with the proper agency.
- Paycheck City is a free, online withholding calculator. This tool allows people to not only calculate federal and all state withholding, but also FICA tax. Self-employed individuals need to take the Medicare and Social Security amounts from the calculator and subtract it from net income to obtain an accurate number. This reflects the self-employment tax and this video is a paycheck city tutorial.
- Quickbooks Self-Employed is a great tool that helps with many tax functions including calculating payroll tax. This tool is very affordable and on sale for just $5/mo.
- Bloomberg BNA is a detailed tax projection that helps businesses and individuals calculate FICA tax, excess Medicare taxes, and social security withholdings. This a great tool to use if a business has a fairly complex tax situation like multiple state income and partnership income.
The government has many sources of income, which include federal taxes, state taxes, sales tax, and FICA taxes. These taxes are used for different reasons, with FICA tax being one of the most important taxes. These taxes provide lifetime income and healthcare for senior citizens and act as a safety net. FICA tax has different subsets, percentages, and rules for employees and self-employed individuals as well. Regardless of a person’s employment status, it’s wise to know the fundamentals of this tax and how to prepare effectively.