Why Is There a Cap on the FICA Tax?

Social Safety and Medicare collectively represent what’s generally known as the Federal Insurance coverage Contributions Act (FICA) tax. Collectively, FICA taxes quantity to fifteen.3% of wages in 2022 and 2023. It breaks down into 12.4% of earned earnings as much as an annual restrict that should be paid into Social Safety and an extra 2.9% that should be paid into Medicare.

There is no such thing as a earnings cap (or wage base restrict) for the Medicare portion of the tax, that means you proceed to owe your half of the two.9% tax on all wages earned for the yr, whatever the sum of money you make. The Social Safety tax, nonetheless, does have a wage-based restrict, which suggests there’s a most wage that’s topic to the tax for that yr, and, past that, there aren’t any extra taxes to pay.

So why is that this? And what are the professionals and cons of the FICA cap?

Key Takeaways

  • Social Safety and Medicare payroll withholding are collected because the Federal Insurance coverage Contributions Act (FICA) tax.
  • Earnings tax caps restrict don’t apply to Medicare taxes, however Social Safety taxes have a wage-based restrict.
  • The cap limits how a lot excessive earners must pay in Social Safety taxes annually.
  • Critics argue that earnings tax caps unfairly favor excessive earners in comparison with low-income earners.
  • Others imagine that elevating the cap would successfully end in one of many largest tax hikes of all time.

How FICA Taxes Work

However first, a fast how-FICA-works evaluate. Mainly, each U.S. taxpayer with earned earnings has to pay it.

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If you’re a waged or salaried worker, you have most likely seen in your paystub and annual W-4 statements these containers marked FICA within the payroll tax part. The sums are your portion of the FICA tax. Half of that tax—6.2% for Social Safety and 1.45% for Medicare—is routinely withheld from every paycheck, and your employer contributes the opposite half.

Then again, if you’re self-employed, you might be answerable for the whole quantity (12.4% for Social Safety plus 2.9% for Medicare, for a complete of 15.3%) your self. However you possibly can usually deduct half of the FICA tax in your federal earnings tax return. That is true for any self-employed particular person incomes greater than $400 per yr and who experiences on and information IRS Kind 1040 Schedule SE.

Understanding Earnings Caps

No matter your employment standing, you may discover that completely different guidelines apply to the 2 forms of FICA taxes. Earnings tax caps don’t apply to Medicare taxes, however Social Safety taxes have a wage-based restrict—that means, they do not apply to earnings above a specific amount. That quantity will get adjusted yearly, reflecting inflation.

The utmost annual earnings which can be topic to Social Safety tax in 2022 is $147,000, for a complete tax of $9,114 for an worker. The quantity for 2023 is $160,200, for a complete tax of $9,932.4. No extra will be withheld out of your paycheck for Social Safety taxes for the yr no matter how a lot you earn.

Benefits and Disadvantages of Earnings Caps

The cap on wages topic to the tax has been the topic of controversy. It signifies that, whereas the typical employee pays tax on each greenback of their earnings—the overwhelming majority earn lower than the wage base restrict—the very best earners pay tax on solely a part of the cash they make. Critics argue that caps on FICA taxes will not be truthful for that cause: They impose extra of a burden on these incomes much less, a regressive tax construction that runs opposite to the American progressive earnings tax system.

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Particular person workers that earn over $200,000 and married {couples} submitting collectively that earn over $250,000 need to pay an extra Medicare tax of 0.9%.

In fact, there’s the idea that decrease wage earners are the prime beneficiaries of Social Safety (versus the rich, who’re assumed to have financial savings and due to this fact want advantages much less)—a part of the unique rationale for instituting the earnings cap within the first place.

As well as, some folks imagine that lifting the cap would end in a major quantity of income that might assist cowl the shortfall Social Safety will quickly face: As of 2022, the Previous-Age and Survivors Insurance coverage (OASI) Belief Fund (which pays retirement advantages), will be capable of make scheduled advantages on a well timed foundation solely till 2034. After that, it’s going to be capable of pay solely 77% of advantages.

Elevating or eliminating the cap on taxable wages would undoubtedly make a distinction. The Social Safety Administration’s Workplace of the Chief Actuary (OCACT) estimates that phasing in a rise within the taxable most (for each contributions and advantages bases) to cowl 90% of lined earnings over the following decade would get rid of roughly one-fifth of this system’s long-range shortfall. OCACT’s estimates additionally present that if all earnings had been topic to the payroll tax, however the current-law base was retained for profit calculations, the Social Safety belief funds would stay solvent for over 40 years.

Do I Have To Pay FICA?

Sure, you do need to pay the FICA tax. There is no such thing as a exemption from the Federal Insurance coverage Contribution Act (FICA) tax. Each person who works and whose job is roofed by Social Safety must pay the tax that’s routinely deducted from their payroll.

How A lot FICA Do I Have To Pay?

The Federal Insurance coverage Contribution Act (FICA) tax consists of two components: Social Safety tax and Medicare tax. The Social Safety tax is 6.2% for the worker and 6.2% for the employer, for a complete of 12.4%. There’s a cap of $147,000 in 2022 ($160,200) in 2023, of which any earnings above that won’t be taxed. The Medicare tax is 1.45% for the worker and 1.45% for the employer, for a complete of two.9%. So the overall FICA tax is 15.3%. There is no such thing as a earnings cap for Medicare however there’s an extra 0.9% tax for people incomes greater than $200,000.

Who Is Exempt From Paying FICA?

“College students that carry out companies for a faculty, faculty, or college the place the scholar is pursuing a course of research” are exempt from paying the FICA tax.

The Backside Line

Any reform of the FICA cap system has its issues. It could be a technique to elevate funds for Social Safety. However having completely different bases for contributions and advantages, for instance, would weaken the standard hyperlink between the taxes staff pay into the system and the advantages they obtain.

Nonetheless, given the significance of the Social Safety system to U.S. staff, caps are positive to be a part of the dialog for some time to come back.