Social Safety and Medicare collectively represent what’s often known as the Federal Insurance Contributions Act (FICA) tax. Collectively, FICA taxes quantity to fifteen.3% of wages in 2021 and 2022. It breaks down into 12.4% of earned revenue as much as an annual restrict that have to be paid into Social Safety and an extra 2.9% that have to be paid into Medicare.
There is no such thing as a revenue 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 12 months, whatever the amount of cash 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 12 months, and, past that, there are not any extra taxes to pay.
So why is that this? And what are the professionals and cons of the FICA cap?
- 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 have to pay in Social Safety taxes annually.
- Critics argue that revenue tax caps unfairly favor excessive earners in comparison with low-income earners.
- Others consider that elevating the cap would successfully lead to one of many largest tax hikes of all-time.
How FICA Taxes Work
However first, a fast how-FICA-works assessment. Principally, each U.S. taxpayer with earned revenue has to pay it.
In case you are a waged or salaried worker, you have in all probability seen in your paystub and annual W-4 statements these packing 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.
However, if you’re self-employed, you might be answerable for all the quantity (12.4% for Social Safety plus 2.9% for Medicare, for a complete of 15.3%) your self. However you may typically deduct half of the FICA tax in your federal revenue tax return. That is true for any self-employed individual incomes greater than $400 per 12 months and who studies on and information IRS Type 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 restrict 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.
For 2021, the wage base restrict for Social Safety taxes is $142,800, a $5,100 improve from $137,700 in 2020. Which means as much as $8,853.60 (6.2%) will be withheld out of your paycheck for Social Safety taxes for the 12 months, however no more, no matter how a lot you earn.
The utmost annual earnings which can be topic to Social Safety withholding in 2022, for a complete tax of $9,114.
When President Roosevelt offered his plan for Social Safety to Congress in early 1935, it didn’t embody an revenue cap. The unique plan exempted excessive earners from Social Safety altogether—together with each taxes and advantages—and anybody who made greater than $3,000 per 12 months was speculated to be overlooked of the system fully.
As FDR’s plan labored its manner via Congress, the exemption for top earners was eradicated, and the Home Methods and Means Committee changed it with a $3,000 cap. Historians have discovered no proof indicating why the committee selected an earnings cap over an exemption, however it has been in place ever since. It has risen on the identical fee as wages within the economic system since 1982.
Benefits and Disadvantages of Earnings Caps
The cap on wages topic to the tax is the topic of controversy, partly as a result of it implies that, whereas the typical employee pays tax on each greenback of their revenue (the overwhelming majority of staff earn lower than the wage base restrict), the very best earners pay tax on solely a part of their revenue. Critics argue that caps on FICA taxes are usually not honest for that motive.
In the meantime, some folks consider that lifting the cap would result in a significant amount of revenue that might assist cowl the shortfall Social Safety will quickly face. Nevertheless, opponents of this concept declare that growing the cap would lead to one of many largest tax will increase of all time.