Net income provides a more accurate account of the financial status. Here’s why.
What is the Federal Insurance Contributions Act?
The Federal Insurance Contributions Act (FICA) tax is a federal payroll tax that provides funds for social services like Medicare and Social Security. The vast majority of workers pay FICA taxes, and everyone pays the same rate regardless of income. FICA taxes are not part of income taxes, although they’re withheld from an employee’s paycheck in the same way, and no deductions or income exemptions apply to them.
FICA taxes are considered regressive taxes in that everyone pays them at the same rate. Currently, employees pay 6.2 percent for Social Security taxes and 1.45 percent for Medicare taxes. Their employers are also required to match the amount paid per employee, meaning that the total FICA contribution is 12.4 percent for Social Security and 2.9 percent for Medicare. Although there is no income limit on Medicare taxes, Social Security taxes are only assessed against the first $127,000 an employee earns each year.
Self-employed workers are also responsible for payroll taxes, but because they are technically both employer and employee, they effectively pay the same 12.4 percent and 2.9 percent rates.
Investment income, such as interest or capital gains, is not charged a FICA tax. Many employees are also exempt from having to pay FICA taxes, including full-time students who only work on campus, religious groups with theological objections to health insurance, and employees of foreign governments. Workers who live in some states that provide alternative retirement plans may also be exempt.
FICA taxes pay for a broad range of federal programs to help the elderly and disabled, but they do not pay for Medicaid, the government insurance program offered to lower-income people. Whereas FICA tax revenue has a close correlation with the federal benefits employees will collect in retirement, programs like Medicaid are drawn from state budgets and can be reduced to make room for other budgetary concerns.
You won’t have to pay FICA taxes on interest in your savings account. Find one with the best rates today.
Matt has been working full time for many years. On each paycheck, he pays a portion of his compensation in FICA taxes, paying thousands of dollars each year toward Social Security and Medicare benefits he hopes to enjoy when he retires. His employer also matches the amount he pays. At 67, Matt finally retires, and he starts collecting the full amount of Social Security payments, off of which he can live his remaining years in some degree of comfort.