Social Security and Medicare together constitute what's known as the Federal Insurance Contributions Act (FICA) tax. Collectively, FICA taxes amount to 15.3% of wages in 2023. It breaks down into 12.4% of earned income up to an annual limit that must be paid into Social Security and an additional 2.9% that must be paid into Medicare.
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, regardless of the amount of money you make. The Social Security tax, however, does have a wage-based limit, which means there is a maximum wage that is subject to the tax for that year, and, beyond that, there are no more taxes to pay.
So why is this? And what are the pros and cons of the FICA cap?
- Social Security and Medicare payroll withholding are collected as the Federal Insurance Contributions Act (FICA) tax.
- Income tax cap limits do not apply to Medicare taxes, but Social Security taxes have a wage-based limit.
- The cap limits how much high earners need to pay in Social Security taxes each year.
- Critics argue that income tax caps unfairly favor high earners compared to low-income earners.
- Others believe that raising the cap would effectively result in one of the largest tax hikes of all time.
How FICA Taxes Work
But first, a quick how-FICA-works review. Basically, every U.S. taxpayer with earned income has to pay it.
If you are a waged or salaried employee, you've probably seen on your paystub and annual W-4 statements those boxes marked FICA in the payroll tax section. The sums are your portion of the FICA tax. Half of that tax—6.2% for Social Security and 1.45% for Medicare—is automatically withheld from each paycheck, and your employer contributes the other half.
On the other hand, if you are self-employed, you are responsible for the entire amount (12.4% for Social Security plus 2.9% for Medicare, for a total of 15.3%) yourself. But you can generally deduct half of the FICA tax on your federal income tax return. This is true for any self-employed person earning more than $400 per year and who reports on and files IRS Form 1040 Schedule SE.
Understanding Income Caps
Whatever your employment status, you'll find that different rules apply to the two types of FICA taxes. Income tax caps do not apply to Medicare taxes, but Social Security taxes have a wage-based limit—meaning, they don't apply to earnings above a certain amount. That amount gets adjusted annually, reflecting inflation.
The maximum annual earnings that are subject to Social Security tax in 2023 is $160,200, for a total tax of $9,932.4. No more can be withheld from your paycheck for Social Security taxes for the year regardless of how much you earn.
Advantages and Disadvantages of Income Caps
The cap on wages subject to the tax has been the subject of controversy. It means that, while the average worker pays tax on every dollar of their income—the vast majority earn less than the wage base limit—the highest earners pay tax on only part of the money they make. Critics argue that caps on FICA taxes are not fair for that reason: They impose more of a burden on those earning less, a regressive tax structure that runs contrary to the American progressive income tax system.
Individual employees that earn over $200,000 and married couples filing jointly that earn over $250,000 have to pay an additional Medicare tax of 0.9%.
Of course, there's the assumption that lower wage earners are the prime beneficiaries of Social Security (as opposed to the wealthy, who are assumed to have savings and therefore need benefits less)—part of the original rationale for instituting the income cap in the first place.
In addition, some people believe that lifting the cap would result in a significant amount of revenue that could help cover the shortfall Social Security will soon face: As of 2023, the Old-Age and Survivors Insurance (OASI) Trust Fund (which pays retirement benefits), will be able to make scheduled benefits on a timely basis until 2033. After that, it'll be able to pay only 77% of benefits.
Raising or eliminating the cap on taxable wages would definitely make a difference. The Social Security Administration’s Office of the Chief Actuary (OCACT) estimates that phasing in an increase in the taxable maximum (for both contributions and benefits bases) to cover 90% of covered earnings over the next decade would eliminate roughly one-fifth of the program's long-range shortfall. OCACT’s estimates also show that if all earnings were subject to the payroll tax, but the current-law base was retained for benefit calculations, the Social Security trust funds would remain solvent for over 40 years.
Do I Have to Pay FICA?
Yes, you do have to pay the FICA tax. Every individual that works and whose job is covered by Social Security will have to pay the tax that is automatically deducted from their payroll.
How Much FICA Do I Have to Pay?
The Federal Insurance Contribution Act (FICA) tax is composed of two parts: Social Security tax and Medicare tax. The Social Security tax is 6.2% for the employee and 6.2% for the employer, for a total of 12.4%. There is a cap of $160,200 in 2023, of which any income above that will not be taxed. The Medicare tax is 1.45% for the employee and 1.45% for the employer, for a total of 2.9%. So the total FICA tax is 15.3%. There is no income cap for Medicare but there is an additional 0.9% tax for individuals earning more than $200,000.
Who Is Exempt From Paying FICA?
"Students that perform services for a school, college, or university where the student is pursuing a course of study" are exempt from paying the FICA tax.
The Bottom Line
Any reform of the FICA cap system has its problems. It would be a way to raise funds for Social Security. But having different bases for contributions and benefits, for example, would weaken the traditional link between the taxes workers pay into the system and the benefits they receive.
Still, given the importance of the Social Security system to U.S. workers, caps are sure to be part of the conversation for a while to come.