History of the Federal Insurance Contributions Act
FICA, the Federal Insurance Contributions Act was enacted in order to prevent retired individuals from being unable to support themselves or their families. The Great Depression showed Americans how easy it was to be financially unprepared for retirement, disability or unemployment.
As a result of the financial ruin experienced by many Americans during the Great Depression, the government stepped in to help taxpayers save for their retirement. Social Security payments throughout a taxpayers lifetime, determine the amount that the individual will receive as income after retirement. In fact, the spouses and children of deceased individuals may also be entitled to collect their Social Security benefits after they have passed away.
Those that are exempt from paying the tax, can not collect the benefits associated with FICA. For example, the Amish are exempt from contributing to Social Security. The courts ruled for that exemption based on the religious belief of the Amish that forbids them from getting insurance.
In that case, the courts ruled that Social Security taxes represent an insurance premium. Because the taxes were considered an insurance premium, the Amish do not have to contribute to Social Security. However, that exemption means that members of the Amish religion are unable to collect Social Security payments after they retire.
Employers must withhold and make a contribution to the taxes as a point of law. The taxes for FICA can not be paid at the end of the year by either the employee of the employer. The tax is cyclical and it applied at every pay period. Employees must match each employees contribution to Social Security and Medicare taxes.
If employers do not do so, they could be hit with fines, penalties, interest on unpaid taxes and the actual taxes due. In other words, employers that do not take the taxes out of employees paycheck, or contribute their portion, are likely to incur a large financial penalty.
The rates that taxpayers pay for Medicare and Social Security are the same for all taxpayers. For most employed taxpayers, the tax burden for Social Security and Medicare is split evenly between the employer and the employee. However, the self-employed are required to shoulder the total tax burden on their own.
The rate of taxes for self employed people is the same, but it is not governed by the Federal Insurance Contributions ACT. Self-employed people are governed by the Self-Employment Contributions Act of 1954 and the tax rate is determined utilizing a different formula.
There are many criticisms associated with FICA taxes. First, taxpayers cite the possibility that the fund will be bankrupt by the time they retire. In other words, taxpayers believe they are making contributions that they will not benefit from. The whole idea of FICA was to help individual taxpayers prepare for retirement. Unfortunately, the reality is that taxpayers that currently make contributions to FICA, many not in fact receive Social Security payments from the government when they retire. In addition, taxpayers complain that the tax is regressive and taxes those with lower incomes at an unfair rate. In any case, taxpayers must currently contribute to FICA and they may not receive the benefits of the program should they become disabled or retire.
Social Security tax rates change at a rather frequent pace. In general, each tax year experience an increase in that tax rate, which also increase the maximum threshold for Social Security tax contributions. However, the maximum threshold will always apply to every taxpayer. In other words, no taxpayer will be responsible for making contributions to Social Security above that maximum. Medicare and other benefits associated with FICA, are taxed in the same way.
However, there is no maximum tax for Medicare. FICA taxes, in addition to other payroll taxes, also fund unemployment and disability insurance. The amount of benefits received by each taxpayer are directly correlated to their amount of lifetimes contributions. In fact, each employed taxpayer receives a yearly report which describes their year long, lifetime and expected contributions to Social Security. In this way, taxpayers are able to plan for their retirement by being aware of what amount of guaranteed Social Security income they can expect.
Federal Insurance Contributions Act Tax:
As a result of the Great Depression, many Americans were left destitute for a variety of reasons. There were many retired, disabled, or unemployed citizens that had no source of income. There were also many Americans that could not afford health care. Those that had savings or investments, often found that their money was suddenly gone. The United States government hoped to avoid future financial disasters for taxpayers, by providing direct benefits for these situations through taxpayer funded programs.
The Federal Insurance Contributions Act tax is imposed on most employees and employers. There are some cases in which taxpayers are exempt from contributing to the tax. In those cases, taxpayers may not collect benefits form the fund. Contributions made through FICA, and other payroll taxes, fund Social Security, Medicare, disability insurance and unemployment insurance. FICA governs all regular employees and their employers. The self- employed are also subject to the taxes but are taxed on their income in a different manner. In the long run, the self-employed are subject to a fair tax when compared to regular employees, although the tax is imposed on slightly different terms.
History and Origins:
FICA, the Federal Insurance Contributions Act resulted from the Great Depression. In fact, previous to the Great Depression, retired individuals were not guaranteed any income. Often, those individuals could not afford health care and they incurred large medical bills when they became ill. During the Great Depression, many families were unable to support themselves. Even families that had savings accounts and other retirement investments, were unable to support themselves due to the economic climate at the time. FICA now allows taxpayers to enjoy direct benefits that are funded through payroll taxes. The responsibility for funding those benefits is placed equally on the employee and the employer.
However, the continuation of benefits for those set to retire in the next several decades is currently in jeopardy. Although the taxpayers have continued to contribute to FICA, there is no guarantee that the fund will still be in place when they retire. Previously, American taxpayers believed that they had a contract for benefits with the government by paying their contribution. However, the ruling in Nestor v. Flemming proved otherwise.
In fact, the government views FICA as a tax imposed on all employees and employers, without the allowable expectation that they will receive benefits when they retire. In Nestor v. Flemming it was claimed that each taxpayer was entitled to benefits simply because they contributed to payroll taxes. Taxpayers are now aware that they are not guaranteed the benefits funded through FICA, they are simply responsible for the tax burden associated with the programs and benefits.
Calculation for Regular Employees:
Regular employees are taxed at a rate of about six percent of their salary in order to meet their Social Security tax burden. However, each tax year, there is a maximum threshold for that tax and no taxpayer is expected to pay more than the maximum. An employee’s total salary is taxed at six percent for Social Security and one and one half percent for Medicare. Social Security payments stop once an employee has met a certain threshold.
Any employee that meets the requirement of a maximum payment for Social Security payments, is not required to contribute further to Social Security. However, employees that change jobs in the middle of a year, may have already met their Social Security tax burden before leaving their original job. That employee must again meet the maximum threshold of payments at their new employer.
That employee can claim any overpayment of Social Security as a credit towards their income tax. Medicare contributions continue for employees at a rate of one and one half percent, regardless of their salary. The Medicare tax continues indefinitely. Neither the Social Security tax or Medicare tax can be reduced through deductions. Unlike income taxes, each taxpayer is required to pay a flat rate of taxes towards FICA, with no manner for reducing their contributions.
Calculation for Self-Employed:
The Social Security and Medicare tax burden for the self-employed is paid completely by the self-employed worker. The self-employed are considered to be both employer and employee and therefore they are responsible for the full tax burden. However, their salary is taxed differently than it would be if they were a regular employee. Percentage wise, the tax is applied the same as regular employees, but the amount of salary is handled differently. Just as a regular employee would not pay taxed on an employers contribution to FICA, self-employed workers can subtract their total tax payments before applying the percentage of tax to their total salary.
The self-employed pay taxes on their net earnings, rather than gross earnings. The rules that govern the taxes of the self-employed are not governed by FICA. In fact, the Self-Employment Contributions Act of 1954 allowed for a different formula to be utilized to determine the Social Security and Medicare taxes of the self-employed. Even though the self-employed worker shoulders the total FICA tax burden on their own, they do not have to contribute an unfair percentage of their overall salary.
There are several circumstances in which employed workers can be exempt from making contributions toward Social Security. For members of the Amish religion, the courts ruled that Social Security contributions were an insurance premium. The Amish are exempt form paying Social Security taxes because insurance is against their religion. The Amish religion expects members to care for each other even in disability, unemployment or retirement. Full time students that work at their school, are also exempt from having to make Social Security contributions.
Students that are in their Medical residency are also exempt. In essence, Medical residents are full time students, which allows for their exemption. Although the IRS continues to fight against the exemption for Medical residents, the exemption currently remains. Social Security income is dependent on each individual taxpayers contributions. Those that enjoy exemptions from Social Security payments, find that they receive a lesser amount of Social Security after retirement. Reduced FICA contributions from taxpayers always results in lesser benefits for that taxpayer, regardless of the reason for exemption.
Many taxpayers claim that taxes for Social Security and Medicare are regressive taxes. Those types of taxes put a larger tax burden on those that have the lowest income. Regressive taxes are imposed as a flat percentage which distributes the tax unevenly as a percentage of income. In other words, those with the lowest salary pay a larger percentage of their income towards their tax burden. The wealthy contribute less of their salary towards the tax based on their salary.
In addition, cases like Nestor v. Flemming have put the rights of those that contribute to FICA taxes or self-employment taxes into questions. Nestor argued that contributions to Social Security represented a contract between the taxpayer and the government. That contract should in theory, entitle the taxpayer to the benefits associated with FICA.
However, the courts ruled that FICA was actually a tax, which meant the taxpayer was not explicitly entitled to the benefits. Yet, in cases that pit religious beliefs against certain taxes, such as FICA, the courts ruled that the tax was actually a payment towards an insurance premium. Currently, most taxpayers expect that their contributions will not entitle them to benefits funded through the tax.
Flemming v. Nestor:
Flemming v. Nestor involved a pivotal decision in which it was determined that making payments towards Social Security, as a part of FICA, does not grant the taxpayer the right to utilize the benefits associated with the program. Many taxpayers mistakenly believe that payments towards Social Security entitled them to collect Social Security when they retire. Nestor believed that his contributions to FICA resulted in a contractual obligation, in which the government agreed to make payments to him after he retired. Had Nester not been deported for his affiliation with the Communist party, he likely would have received Social Security payments.
However, Social Security would not be paid once he was deported. In this case, the courts ruled that a taxpayer’s contribution to Social Security, is indeed a tax. Because Social Security is a tax, payment does not constitute any contract between the government and the taxpayer.
Nestor contended that payroll taxes were a payment for the benefits to be enjoyed after retirement. However, in cases involving the Amish religion and Social Security payments, the courts have ruled that Social Security payments are an insurance premium, which exempts the Amish from having to make payments. Cases like these will be cited in the near future, as the FICA fund begins to run dry.