When you received your first paycheck, you were probably surprised to discover that what you told you are earning, and what you actually come home with, are two different things. Due to tax withholding from your paycheck, your take-home pay is usually less than you earn.
Your federal and state income tax payments are usually withheld from your paycheck, and you might even expect that since you usually need to fill out a W-4 when you begin working. However, what you might not account for is the withholding of FICA taxes.
These taxes are different from income tax. FICA taxes are designed to take money from your paycheck and apply it toward future benefits. FICA taxes include Social Security and Medicare withholdings. These taxes are meant to go into a fund. Later on in life, after you have worked, you are eligible to receive Social Security benefits to help supplement your income and sign up for Medicare benefits to help you cover the costs of health care.
For 2016, the rate for FICA taxes is 15.30%. Part of that is Social Security (12.40%) and part is Medicare (2.90%). It’s important to note, first of all, that you only pay the Social Security portion on the first $118,500 of your earned income. That means that once you make more than that, you aren’t assessed Social Security tax. The Medicare portion is assessed on all your earnings, with no limit.
Another consideration is that there is a good chance you aren’t paying that entire 15.30% on your own. Instead, your employer is probably picking up the tab for half of it. If you are an employer who is issued a W-2, your employer is probably paying 7.65% of your income toward FICA taxes, while you pay the remaining 7.65%. This can make a big difference in the long run. You still benefit from the programs down the road, but you don’t have to pay the full amount in taxes.
The situation is different if you are self-employed, though. As a self-employed person, you are still responsible for FICA taxes. However, you don’t have an employer to help you pick up the tab. Instead, you pay the entire amount on your own. In order to offset the burden associated with being self-employed and paying that total amount, half of the amount you pay is actually tax-deductible on your Form 1040 when you are figuring your taxes. That can help you reduce the pain that comes from FICA taxes as a self-employed person.
However, it doesn’t always feel as though you are receiving an advantage because you are paying the bill all at once (or paying quarterly), rather than having the amount taken from your pay in smaller, regular increments.
No matter your situation, you will be subject to FICA taxes if you have earned income. Whether you work for an employer or are self-employed, make sure you plan for that reality so that you aren’t unpleasantly surprised at tax time, or when you get your paycheck.