January 9, 2015
What is the FICA tax? When do you pay it and when do you not?
What is the FICA tax? When do you pay it and when do you not?
The FICA tax is also known as the Federal Insurance Contribution Act Tax. It is a tax imposed on employers and employers to fund social Security and Medicare. These taxes are deducted from each pay check. If you are self employed and you make more than $400 a year you must report it and pay taxes on it.
The FICA tax is a tax paid on wages earned. FICA stands for Federal Insurance Contributions Act. The intention of FICA is to provide basic pension and medical coverage to the retired and disabled. FICA amounts to 15.3% of your paycheck. For individuals who are employed by someone else, the employer pays half and you pay the other half which equates to 7.65%. Of the 15.3%, it is broken down as follows: Social Securiity-12.4% and Medicare-2.9%. If you are self employed, you are responsible for the whole thing. The Social Security portion is only paid on wages up to $117,000, but the Medicare portion is charged to all of your earned wages. Special circumstances exist where this number changes slightly. If you are a high wage earner, the Medicare portion jumps from 2.9% to 3.8%. This additional 0.9% is paid by you and not split with your employer.
It is important to note that the FICA tax is only paid on earned income. Therefore, at some point if you have invested wisely you will begin to receive income from your investments, which is considered unearned income, and will not have to pay the FICA tax
FICA taxes are your payroll taxes, they come out of your earned income. FICA goes towards social security and medicare. There is a cap on the social security portion but not on the medicare side. You do not pay FICA on earning from investments or other passive income. That is why you want to make as much passive income as you can, the passive income will have less taxes on it due to not having a FICA side.
Well said, gentlemen. You covered all of the key points. Let’s recap.
(1) You pay FICA on earned income.
(2) You don’t pay FICA on unearned income.
(3) One way to reduce your taxes is to generate more unearned income.
(4) You can do that with investment income, rental property, royalties, pensions, etc.
(5) Work at diversifying your income streams. The more passive income you are making, the less earned income you will need!