FICA Tax – What is it and why’s it matter?
Anyone that has inspected their paychecks for the myriad taxes and deductions from their paychecks has surely noticed the FICA Tax line on there. The Federal Insurance Contributions Act (FICA) tax is a federal tax on both employees and employers to fund Social Security and Medicare. It’s an even split of 7.65% of the employee’s salary – but only up to a certain cap for the Social Security piece. The limit of only applies to the 6.2% FICA and not to the complete 7.65%. The medicare portion has no upper limit or cap. That’s why it’s important to know what the cap is, especially if you’re on the fringe in a given year.
Based on the table below, an employee making $106,800 or less in any given year can expect to pay the full 7.65% on every paycheck of the year. However, let’s say you make $126,800 in a particular year. You’ll actually see an artificial “raise” of several hundred dollars in your last couple paychecks. In this case, the additional $20,000 over the limit * .062 = $1240 additional cash in hand you’ll see in the final couple paychecks in aggregate.
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FICA Limit Implications and Tactics
Let’s say you have variable income or you have a significant bonus that you have some control over (you could request to take it this year or next, or if you’re self-employed, you’re able to legally manipulate when you realize earnings). If you’re at $90,000 for instance this year and have a $15,000 bonus coming to you, you’re going to pay the full 7.65% on the full amount no matter what since even $105,000 is under the FICA limit. In your case, you may be expecting a raise and more bonuses next year to catapult you way over the limit, so it would be optimal to maximize earnings in 2010 and just realize the benefit next year with every dollar you can push into next year.
Conversely, let’s say you don’t expect a raise next year and you’re already at $106,800 – you may want to pull in earnings into this year to be able to realize the additional cash benefit in 2009. When considering factors like this, don’t lose sight of the forest through the trees – there’s opportunity cost, your cost of cash/inflation, legal/company policy issues and other factors that should be considered holistically. But for some, there may be some utility in trying to manipulate the timing of income to realize this 6.2% benefit. If you’re self-employed, it’s a double benefit of 12.4%.
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2009 FICA Tax Limit -$106,800
2010 FICA Tax Limit – $106,800
Prior Years:
2005 – $90,000
2006 – $94,200
2007 – $97,500
2008 – $102,000
FICA Tax Limit Irony
What’s rather ironic about the FICA tax limit in prior years (at least to me) is that it’s indexed to inflation – actually, it increased at a rate somewhat higher than the typical 2-3% inflation, whereas Congress, in their infinite wisdom intentionally does not consider inflation for things like the Alternative Minimum Tax (so they need to pass a patch each year and then pat themselves on the back when it finally gets done) or for the poorly conceived Health Care legislation which will tax “the rich” making over $250,000 while not indexing that amount to inflation. Surely, the most rudimentary understanding of inflation and compounding would dictate that those people you’re calling “rich” today may not necessarily be rich in 20 years at a given income. For instance, back when the AMT was envisioned, it was hitting people making $75,000 because they were “rich”. Nowadays, if you live in a high cost area (of course, there’s no regional cost-of-living consideration for any of these taxes either) and you’re trying to support a family of 4 on a $75,000 income, is the AMT for you? Probably not, but many Americans at that level still get hit each year. But I digress – FICA IS indexed to inflation most years, and if you’re right on that cusp of just making that annual limit each year, you’ll continue to pay in full every year and never get the break I alluded to in your November, December paycheck, etc.
FICA Tax in future years 2011 and Beyond
If the administration had their way, they’ll probably seek to significantly raise the FICA limit to “spread that wealth around” which would be commensurate with many other policies from mortgage modification to the first time home buyer tax credit.
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It was a nice read. I just wanted to point out that the breakdown of 7.65 percent is as follows
6.2 % FICA
1,45 % Medicare
The limit of 106,200 only applies to the 6.2% FICA and not to the complete 7.65%. The medicare portion has no upper limit or cap.
Regards,
SK
[Reply]
Ah yes, thanks for that clarification; I’ve updated article to reflect.
[Reply]
Nice overview Darwin. It’s sad that the gov’t RAISED the income to $106,800, despite the spectacular HAMMERING of income over the past 2 years.
Let’s keep the income limit at $50,000!
[Reply]