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.
Special 2011 FICA Tax Rate due to Payroll Tax Break
As part of the deal Obama forged to extend unemployment benefits at the end of 2010, not only did tax rates stay the same across the board, but he also enacted what amounts to a substantial stimulus package by way of reducing the FICA rate by 2% to 4.2% for employees. In effect, this is a 2% bonus to all workers up to the cap of $106,800.
Another noteworthy item for the 2011 FICA Tax Cap is that again, for the third year, the cap remains the same, at $106,800. Even though commodity prices are skyrocketing, healthcare costs are rising, and virtually everything else we routinely buy now costs more than it did a year ago, the inflation index the government uses didn’t warrant an increase. So, at least in that regard, Americans got a bit of a break – if it matters (only to 6 figure earners really, since below the threshold you pay the full 4.2% this year regardless).
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 2011. 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%.
2011 FICA Tax Limit – $106,800
2005 – $90,000
2006 – $94,200
2007 – $97,500
2008 – $102,000
2010 – $106,800
FICA Tax in future years 2011 and Beyond
Unfortunately for government coffers, the FICA increases are tied to inflation indices which tend to underestimate the real inflation Americans are seeing. Not only did we not see a FICA cap increase, but this year, Social Security recipients did not see a cost of living adjustment (COLA) either. So, in the end, I guess it balances out somewhat from a tax revenue standpoint net-net. But the Social Security fund is due to be depleted in 2037 and striking the 2011 2% reduction didn’t help matters. In future years, it wouldn’t surprise me if Congress enacted a new cap to make up the difference. If they increased it to say, $140,000 overnight, the vast majority of Americans would probably applaud it, while this would go a good way in bridging the Social Security fund depletion. After all, that’s a lot more politically savvy than increasing the retirement age or decreasing benefits to seniors, right? So, enjoy the bonus while you can – if you’re getting it in 2011.
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