What Is FICA Tax: How It Works And Why You Pay

what is fica what it is and how it works

Just like the FUTA tax, the Federal Insurance Contributions Act (FICA) tax is a crucial part of your paycheck that goes towards supporting two significant programs: Social Security and Medicare. But what exactly is FICA tax, and how does it work? Let’s dive in.

FICA breakdown where do your taxes go

What is FICA Tax?

FICA tax is a federal payroll tax that both employees and employers contribute to.

  • Employees contribute by having the tax withheld by the employer from their earnings.
  • Employees contribute by matching the tax withheld from employee earnings.

It’s split into two parts: Social Security tax and Medicare tax. The Social Security tax supports the Old-Age, Survivors, and Disability Insurance (OASDI) program. The Medicare tax supports the Hospital Insurance (HI) Medicare program.

These funds go directly towards supporting these supplemental income and insurance programs, which provide benefits for retirees, the disabled, and children of deceased workers. Over time, these tax rates have increased since the inception of the programs.

A Brief History of FICA

On What’s called “Black Monday” on October 28, 1929, the U.S. stock market crashed when the Dow Jones Industrial Average plunged amid bank runs and sell-of panic. What followed was a period of consistent wealth erasure and economic decline now known as the Great Depression. When Franklin D. Roosevelt took office as president of the U.S in 1933, he began enacting his campaign promises in the New Deal, which included creating a social safety net for America’s most vulnerable citizens. In 1935, empowered with a strong congressional majority, Roosevelt signed the Social Security Act. To fund the payroll tax created by the Social Security Act, the Federal Insurance Contributions Act (FICA) was passed.

FICA Medicare Tax Rates Over Time
Medicare Tax Rates Over Time
FICA Social Security Tax Rates Over Time
Social Security Tax Rates Over Time

The act was revised periodically, increasing tax rates, expanding coverage to more Americans. In 1965, Medicare was introduced as part of the Social Security Amendments of 1965, and signed into law by President Johnson. A separate payroll tax was established to fund Medicare, providing health insurance to individuals aged 65 and older. As of 2023, FICA now consists of two separate tax rates.

How Does FICA Tax Work?

FICA tax is calculated as a percentage of an employee’s gross pay, and to be even more specific, their taxable income, subordinate to pretax deductions such as 401k employee contributions and Section 125 “cafeteria plan” health insurance deductions. As of 2023, the Social Security tax rate is 6.2%, and the Medicare tax rate is 1.45%, making a total FICA tax rate of 7.65% for employees. Employers are obligated to match this contribution, effectively doubling the amount that goes into these programs.

This makes the total 15.30% when the employer contribution and employee withholding are combined.

The Impact of FICA Tax

impact of fica payroll tax

While no one likes seeing deductions from their paycheck, the FICA tax serves a crucial purpose. It funds programs that millions of Americans rely on for healthcare and financial support during retirement or in times of disability. As an employer, understanding FICA tax can help you better explain paycheck deductions to your employees and ensure you’re meeting your tax obligations.

Your Employees’ Questions About FICA

Do your employees have questions about FUTA in their pay statements? Send them to the IRS Tax Withholding Estimator. You as the employer can use it too:

IRS Tax Withholding Estimator

In Summary

FICA tax is more than just another line item on a pay stub. It’s a vital contribution to programs that support Americans once they reach “the age of wisdom” and represents that only social safety net guaranteed to Americans, regardless of your retirement income. By understanding what FICA tax is and how it works, both employers and employees can better appreciate where this portion of their paycheck goes. Your present contributions will fund your elders’ retirement at a basic level, and ensure that those benefits continue to be available into your own old age.

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Cody Bess