Why is there a cap on the Federal Insurance Contribution (FICA) tax?

By Jean Folger AAA
A:

Social Security and Medicare payroll withholding are collected as the Federal Insurance Contributions Act (FICA) tax. 12.4% of earned income up to an annual limit must be paid into Social Security, and an additional 2.9% must be paid into Medicare. If you are a waged or salaried employee, half of the payroll tax - 6.2% for Social Security and 1.45% for Medicare - is automatically withheld from each paycheck, and your employer contributes the other half. If you are self-employed, you are responsible for the entire amount (12.4% for Social Security plus 2.9% for Medicare), but you can generally deduct half of the FICA tax on your federal income tax return.

There is no income cap (or wage base limit) for the Medicare portion of the tax, meaning you continue to owe your half of the 2.9% tax on all wages earned for the year. The Social Security tax, however, has a wage base limit - the maximum wage that is subject to the tax for that year. For earnings in 2014, the wage base is $117,000. That means up to $7,254 can be withheld from your paycheck for Social Security taxes - but not more, regardless of how much you earned.

When President Roosevelt presented his plan for Social Security, it did not include an income cap. The original plan exempted high earners from Social Security altogether - including both taxes and benefits - and anyone who made more than $3,000 a year (about $52,000 in 2014 dollars) was supposed to be left out of the system completely. As FDR's plan worked its way through Congress, the exemption for high earners was eliminated, and the House Ways and Means Committee replaced it with a $3,000 cap. Historians on the subject have found no evidence supporting why the committee chose an earnings cap over an exemption, but it has been in place ever since. Since 1982, it has risen at the same rate as wages in the economy.

The cap on wages subject to the tax is the subject of controversy, in part because it means that while most workers pay the tax on every dollar of their income (because the vast majority of workers earn less than the wage base limit), the highest earners pay tax on only a part of their income. Proponents state that lifting the cap would result in a significant amount of revenue that could help cover the shortfall Social Security will soon face, while opponents claim it would result in one of the largest tax increases of all time.

 

RELATED FAQS

  1. What are the Social Security tax caps?

    Learn how the Social Security tax cap works, what percentage of income is deducted for Social Security taxes and the history ...
  2. What's the difference between Social Security Disability Insurance (SSDI) and Supplemental ...

    Both Social Security Disability Insurance and Supplemental Security Income are administered by the Social Security Administration, ...
  3. Will I pay taxes on my Social Security payouts?

    Find out if you're one of the people who has to pay federal income taxes on the Social Security benefit you receive.
  4. At what age will I be eligible for the maximum Social Security payout?

    The year you choose for collecting your social security will play a large part in determining how much money you'll receive ...
RELATED TERMS
  1. Federal Insurance Contributions Act - FICA

    A U.S. law requiring a deduction from paychecks and income that ...
  2. Section 7702

    The section of the United States Internal Revenue Code that defines ...
  3. Creditable Coverage

    A health insurance, prescription drug, or other health benefit ...
  4. Medigap

    Also called Medicare Supplement Insurance, Medigap is health ...
  5. Guaranteed Issue Rights

    A right afforded to individuals insured under Medicare that requires ...
  6. Lifetime Reserve Days

    The number of hospital days that an insurance policy will cover ...
Related Articles
  1. The Medicare Part D donut hole can confound the best of us. Here's what financial advisors and their clients should know.
    Investing Basics

    'Donut Hole' Essentials For The Financial ...

  2. We asked more than 27,000 investors across 20 countries questions related to financial issues, from retirement to savings to asset allocation.
    Economics

    How did 27,000 investors answer to these ...

  3. Venezuela has more oil than anyone, and Brazil and Argentina have lots going for them, too, so why can't they get out of their own way economically?
    Economics

    Where NOT To Invest in Latin America

  4. Understanding the basics of Medigap.
    Insurance

    Medigap Insurance: Who Needs It?

  5. National Debt Clock
    Economics

    The Top Reasons Behind The U.S. National ...

Trading Center