Payroll - FICA tax deductions

🇺🇸

, also known as FICA (Federal Insurance Contributions Act) or FICA tax, is a tax in the United States against earned income.

It has three components: Social Security tax on earned income up to the Social Security Wage Base ($160,200 in 2023); Medicare tax on all earned income; and the Additional Medicare Tax on earned income above $200,000 for single taxpayers or $250,000 for married couples (implemented by the Patient Protection and Affordable Care Act (ACA)).

The employee and employer share the Social Security tax and Medicare tax. Each pays half the tax, and the employer must withhold the employee's half of these two taxes from the employee's paychecks.

The employee pays any Additional Medicare Tax entirely, although employers are required to withhold the Additional Medicare Tax on all wages in excess of $200,000, without regard to the employee's filing status.

Description
The following table summarizes payroll taxes:

Details:
 * Payroll taxes are assessed against earned income (also called wages) only. Investment income (interest, dividends, and so on ), real estate income reported on IRS Schedule E, and income from Partnerships or S Corporations reported on IRS Schedule K-1 (Form 1065) or IRS Schedule K-1 (Form 1120S), is not assessed payroll tax.
 * Contributions to Traditional 401(k)'s and IRAs are not payroll tax-deductible, only income tax-deductible.
 * Contributions to employer cafeteria plans, such as Health Savings Accounts (HSAs) and health insurance are payroll tax-deductible. The same type of contribution made outside those plans (e.g., directly to the HSA provider, or premiums for non-employer-provided health insurance) are not payroll tax-deductible.
 * Employers are required to withhold the employee's half of Social Security and Medicare tax from their paychecks.
 * Employers are also required to withhold the Additional Medicare Tax on all wages in excess of $200,000 per year, regardless of the employee's filing status.
 * Self-employed sole proprietors are required to pay both halves of the payroll tax, calculated on IRS Schedule SE (Form 1040). On the Schedule SE, net business profits are scaled down by a factor of 92.35%, so that the sole proprietorship gets to deduct the employer half of payroll taxes, similar to a corporation.
 * S Corporation owners are also required to pay both halves of the payroll tax, although they have the option to split compensation between wages and dividends, within certain restrictions, potentially reducing payroll tax (see below).
 * The Social Security Wage Base is adjusted annually by the Social Security Administration. Over the last several years, the figure has been increased by 3-4%/year, except for a 9.0% increase in 2023 due to high inflation.
 * The income thresholds for the Additional Medicare Tax ($200,000 for single filers and $250,000 for married joint filers) are not indexed for inflation.

Exemptions from paying payroll tax
Generally, you are not allowed to "opt out" of paying payroll taxes, even if you are willing to forgo future Social Security and Medicare benefits. However, certain types of jobs are exempt from payroll taxes, such as:


 * Children under age 18 employed by their parents through a sole proprietorship or partnership, but not a corporation
 * Certain international workers within the United States, such as nonresident alien employees of foreign governments, students, and employees of international organizations.
 * Full-time students employed by their university
 * Members of certain exempt religious organizations

You must still pay Social Security tax even if you accumulate 35 years of earnings at or above the Social Security Wage Base.

Recovering excess payroll tax
If you are an employee and you work two or more jobs in a given year (either serially or concurrently), your employers must withhold Social Security tax from each paycheck. If your total wages are more than the Social Security Wage Base (SSWB, $160,200 in 2023), then you will have excess Social Security tax withheld. You can recover the excess Social Security tax. Enter claims for credit onto IRS Form 1040 Schedule 3, on Line 11 of your federal income tax return. You can either apply the credit to income tax you owe, or have it returned as part of your tax refund.

If your employer withholds excess Social Security in error, you should seek a refund from your employer. If this is not successful, you can request a refund on IRS Form 843.

While employees are entitled to a refund for excess Social Security tax, employers are generally not entitled to a refund for their half of Social Security tax payments if the employee worked another job and overpaid. This affects business owners, and can have a particularly large impact on taxpayers who own their own business through a Corporation, and also work a second job as an employee.

The Corporation is required to pay the employer side of the Social Security tax up to the SSWB, even if the owner knows that some of this tax is on wages in excess of the SSWB. This issue does not affect Sole Proprietors who work a second job as an employee, because IRS Schedule SE (Form 1040) corrects for Social Security tax paid from other employment.

Because the Medicare tax is assessed on all earned income, working for multiple employers does not create excess Medicare tax. However, the Additional Medicare Tax can create situations of under- or over-withholding. Employers must withhold Additional Medicare Tax on employee wages above $200,000, regardless of the employee's filing status.

For example, a married employee who earns $250,000 of wages, and whose spouse does not work, will have $450 (($250,000 - $200,000) * 0.9%) of Additional Medicare Tax withheld, even though their actual Additional Medicare Tax due is $0. Conversely, a married couple who each earn $200,000 of wages will owe $1,350 (($400,000 - $250,000) * 0.9%) of Additional Medicare Tax, even though none will be withheld.

In both cases, IRS Form 8959 corrects this on their federal return. The IRS requires this form for all federal tax returns subject to the Additional Medicare Tax.

Avoiding payroll tax
For most taxpayers, there are no legal ways to avoid payroll taxes. However, owners of S Corporations may decide to split their compensation partly as wages and partly as dividends from the business, reducing payroll taxes because they are not assessed on the dividends. This split is subject to the IRS requirement for "reasonable compensation."

Even if a business owner is legally entitled to pay lower payroll taxes, there may be compelling reasons not to, such as the cost of becoming and remaining incorporated (compared to operating as a Sole Proprietor), lower employer contributions to a Solo 401(k), and a potentially desirable rate of return on Social Security tax paid.

You can also avoid payroll tax when contributing to a Health Savings Account through an employer payroll deduction. If the investment characteristics of Social Security tax (for example, rate of return) are desirable, you can make the payment directly to the HSA custodian.