Learning objectives

• Recall that the Federal Insurance Contributions Act (FICA) tax applies to the funding of Social Security retirement, disability benefits, and Medicare benefits.
• Recognize how the additional Medicare tax operates.
• Identify instances in which there is no requirement for FICA taxation.

Overview

On August 14, 1935, the Social Security Act established a delivery system to provide old-age benefits for eligible workers, assistance for victims of industrial accidents, unemployment insurance benefits, and aid for dependent mothers and children, the blind, and the physically handicapped.

In 2016, the Social Security Administration (SSA) paid more than $1 trillion to more than 62 million recipients; 75% were retired workers and their dependents, 16% were disabled workers and their dependents, and 9% were survivors of deceased workers.

The Social Security Act authorized the Social Security Board, which now operates as the Social Security Administration, to register citizens for benefits, administer the contributions received by the federal government, and send payments to recipients. U.S. Social Security “insurance” is supported from “contributions” in the form of taxes on individuals’ wages and employers’ payrolls rather than directly from government funds. Tax revenue generated from the income tax on Social Security benefits received by the IRS from individuals’ personal income tax returns is also a source of funds to be paid to Social Security recipients.

A brief history of the Social Security Act

Before the 1930s, support for the elderly was generally the responsibility of the older individual’s family rather than that of the federal government (except for veterans’ pensions). However, in light of the economic nightmare caused by the Great Depression, congressional support for numerous proposals for a national old-age insurance system arose. On January 17, 1935, President Franklin D. Roosevelt sent a message to Congress asking for “economic security” legislation.

The same day, Senator Robert Wagner of New York and Representative David Lewis of Maryland introduced bills reflecting the Roosevelt administration’s wishes. The resulting Senate and House bills encountered opposition from those who considered it a governmental takeover of individual choice and from those who sought exemption from payroll taxes for employers who adopted government-approved pension plans. Eventually the bill passed both houses, and on August 14, 1935, President Roosevelt signed the Social Security Act into law. Originally, the Social Security Act of 1935 was named the Economic Security Act, but this title was changed during a Ways and Means Committee meeting on March 1, 1935. Congressman Frank Buck (D-Calif.) made a motion to change the name of the bill to the “Social Security Act of 1935.” The motion was carried by a voice vote of the committee.

Through the 80th anniversary of Social Security in the year 2015, the Social Security Act has had 12 major legislative changes. The changes have mostly added more workers subject to withholding of Social Security tax on wages, increased the age of eligibility, adjusted the amount of wages subject to Social Security withholding, and other changes meant to shore up what was a shortage of Social Security tax collections at various times in history.

The Bipartisan Budget Act of 2015 passed in November of 2015 rescinded two favorite methods of collecting Social Security benefits: the file and suspend and the restricted application for spousal benefits only at full retirement age (FRA). The two methods were first introduced in the Senior Citizens’ Freedom to Work Act of 2000.

File and suspend was a strategy that allowed a worker to file for Social Security benefits at full retirement age and then immediately suspend receiving those benefits to a later age up to age 70. The filing part allowed a spouse or qualifying child to start receiving Social Security benefits on that worker’s record even though the worker was delaying their own benefit. File and suspend is still allowed for those workers who were 66 by April 30, 2016. After that date, a spouse or qualifying child will only be allowed to collect a benefit on a worker’s record if that worker is actually collecting a benefit. Suspension of benefit collection is still available, meaning that a Social Security recipient between the ages of 62 and 70 can suspend collection of benefits and get additional credits from that moment to age 70. However, as of April 30, 2016, spousal and dependent benefits of that worker are also suspended.

Restricted application is a strategy that became popular after being introduced in the Senior Citizens’ Freedom to Work Act. It allowed a spouse at full retirement age to elect to collect only a spousal benefit on their spouse’s work record and defer the collecting of his or her own benefit to age 70, collecting an 8% per year credit to their own benefit. People born in 1953 and earlier will still be allowed to file a restricted application. Those people born after 1953 will get the higher of their own benefit or the spousal benefit when they file for Social Security benefit no matter what age they file for the benefit. Therefore, restricted application is still available for those turning age 66 for the next two years.

Lump sum was also eliminated in the Bipartisan Budget Act. The lump sum allowed a person to file and suspend at full retirement age and then at a later age, before age 70, change their mind and collect a lump sum benefit for all of the benefits they would have started receiving at full retirement age to their current age, and also get a monthly benefit starting immediately as if they had begun collecting benefits from full retirement age. The lump sum is only allowed for people who were age 66 by April 30, 2016.

Knowledge check

1. Which began in 1935?
   1. Social Security.
   2. Medicaid.
   3. SSI.
   4. Medicare.

The Social Security Administration

In 1953, the SSA was placed under the Department of Health, Education, and Welfare, which became the Department of Health and Human Services in 1980. In 1994, President Bill Clinton signed 42 USC Section 901 returning the SSA to the status of an independent agency in the executive branch of government.

FICA tax

Social Security's Old-Age, Survivors, and Disability Insurance (OASDI) program and Medicare's Hospital Insurance (HI) program are financed primarily by employment taxes.

Social Security payroll taxes are collected under the authority of the FICA.

The payroll taxes collected for Social Security function as contributions to the social insurance system, commonly known as Social Security. Essentially, FICA operates as the tax provision of the Social Security Act as it appears in the IRC.

Individuals generally never stop paying Social Security and Medicare taxes on work or self-employment earnings, regardless of their age or whether they concurrently receive benefits. Employers continue to be responsible for the matching portion of Social Security and Medicare taxes.

Tax rates are set by law (see Compilation of Social Security Laws at https://www.ssa.gov/OP_Home/comp2/F083-591.html) and apply to earnings up to a maximum amount (https://www.ssa.gov/OACT/COLA/cbb.html#Series) for OASDI (https://www.ssa.gov/OACT/ProgData/taxRates.html).

FICA tax includes two separate taxes. One is Social Security tax and the other is Medicare tax. Different rates apply for each of these taxes.

The current tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, or 12.4% total. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total.

Only the Social Security tax has a wage base limit. The wage base limit is the maximum wage that is subject to the tax for that year. For earnings in 2019, this base is $132,900.

There is no wage base limit for Medicare tax. All covered wages are subject to Medicare tax.

Base rates for FICA and Medicare tax rates have not changed and a 0.9% Medicare tax on earned income applies to certain upper-income taxpayers.

Medicare tax

Medicare is taxed at 1.45% of wages, and, unlike the retirement and disability portions of FICA tax, there is no wage base limit. Employers are also required to match this contribution, bringing the total funding to 2.9% of all wages earned.

Medicare tax on earned income

As of 2013, and ostensibly for the foreseeable future, high-income households will pay more into Medicare as a result of the health care reform law, known as the Patient Protection and Affordable Care Act (ACA) or, more colloquially, “Obamacare.”

The Medicare payroll tax, which, unlike the retirement portion of FICA tax, applies to unlimited amounts of earned income, has increased for individuals making more than $200,000 in wages, and joint filers making more than $250,000.

The current 2.9% Medicare tax on wages is payable one-half by the employer and one-half by the employee. The ACA does not change the employer portion. Instead, the new 0.9% Medicare tax will be payable solely by the employee and is levied in addition to the current Medicare payroll tax.

Under the new law, which became effective in 2013, high-income individuals pay another 0.9 percentage point, so their share will total 2.35% of their wages.

Note that the tax applies to earned income more than the income thresholds, rather than to adjusted gross income (AGI).

In this example, the employer must begin withholding the surtax in the pay period in which it pays wages in excess of the $200,000 (assuming single filing status) “floor” to Pam and it must continue to withhold it each pay period until the end of the calendar year.

Keep in mind that the following thresholds of wages (and not AGI) trigger the tax:

The 0.9% Medicare surtax applies to wages, compensation, and self-employment earnings greater than a threshold amount that is based on the employee’s filing status. Once the threshold is reached, the tax applies to all wages that are currently subject to Medicare tax, the Railroad Retirement Tax Act, or the Self-Employment Compensation Act.

An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual’s filing status or wages paid by another employer. An individual may owe more than the amount withheld by the employer, depending on the individual’s filing status, wages, compensation, and self-employment income. In that case, the individual should make estimated tax payments and request additional income tax withholding using Form W-4, Employee’s Withholding Allowance Certificate.

The value of taxable wages not paid in cash, such as noncash fringe benefits, are subject to Additional Medicare Tax, if, in combination with other wages, they exceed the individual’s applicable threshold.

It is interesting to note that this rule applies even if both spouses work for the same company.

Medicare tax on net investment income

Since January 1, 2013, the Healthcare and Education Reconciliation Act of 2010 that clarified the ACA applied a 3.8% Medicare tax to unearned income for certain high-income individuals. Specifically, the 3.8% tax applies to the lesser of (1) an individual’s “net investment income” and (2) the excess of the individual’s modified AGI more than $200,000 ($250,000 applicable to a joint return).

Not everyone is covered under Social Security

When the Social Security program began, certain groups of workers were already covered under other retirement plans. Railroad workers were covered under the Railroad Retirement Board. Workers covered under the Railroad Retirement program do not fund or receive retirement benefits from Social Security, but they may buy into Medicare. Federal government employees (including members of Congress) were covered by the Civil Service Retirement System. Those who have been continuously employed by the federal government starting before 1984 do not fund or receive retirement benefits from Social Security. Today, members of Congress pay into the system.

Employees whose services are not covered for Social Security, but who are required to pay the Medicare-only portion of FICA, are referred to as Medicare Qualified Government Employees.

Summary

Our Social Security system provides retirement, disability, and survivor benefits to tens of millions of Americans. Most benefits are funded through FICA taxes, shared by workers and their employers, although newer Medicare taxes apply to workers alone. With few exceptions, earned income such as wages, tips, commissions, and more are subject to FICA tax. FICA tax itself falls into two categories—the OASDI (generally, retirement) portion and the Medicare portion. FICA tax on the OASDI portion applies only on wages up to an annually indexed taxable wage base. In contrast, the Medicare portion of FICA tax generally applies to all income.