FICA taxes are those arising from the 1937 law—the Federal Insurance Contribution Act (FICA). These taxes include contributions to both the federal Social Security and Medicare programs, and must be paid by all American workers, whether they are employed by a company or are self-employed. The way in which the payment is made varies but anyone employed for pay owes FICA taxes.
Small businesses that employ persons other than the owner or partners are required to withhold FICA taxes—along with regular income taxes—from the wages paid to employees. These taxes are remitted on a monthly or semi-weekly basis, depending on the quantity owed. Businesses are also required to make regularly scheduled reports to the IRS about the amount of taxes owed and paid. Businesses are not required to withhold FICA taxes on wages paid to independent contractors. Self employed persons are responsible for paying their own FICA taxes directly to the IRS on a quarterly basis.
FICA taxes are assigned to two programs and the tax rate for each program is different. In 2006, the employer is required to withhold 6.2 percent of the first $94,200 of an employee's income for the Social Security portion of the employee's FICA taxes (also known as Old Age Survivors and Disability Insurance or OASDI). The Medicare portion is 1.45 percent of the employee's entire income. As a result, the full employee's portion of the FICA tax is 7.65 percent on the first $94,200 of income and 1.45 percent on all income over $94,200. The FICA tax percentages have remained constant since 1990 but the top income rate taxable for Social Security is adjusted annually.
In addition to the portion withheld from employees, employers are required to match the 7.65 percent employee contribution, so that the total FICA contribution is 15.3 percent. Self-employed persons are required to pay both the employer and employee portions of the FICA tax.
The timeliness of FICA tax payments to the IRS is very important. The IRS penalizes late payers with significant penalties and interest. The regular income taxes and the portion of the FICA taxes that are withheld from employees' wages each pay period must be remitted to the IRS monthly (or semi-weekly in the case of an employer whose payroll taxes owed exceed $50,000 in the period), along with a Federal Tax Deposit Coupon (Form 8109-B). If the total tax due is less than $500, however, the business is allowed to make the payments quarterly. FICA tax payments also must be reported on Form W-2, the Annual Statement of Taxes Withheld, which must be sent to all employees and to the Social Security Administration before January 31 of the following year.
Small businesses are also required to maintain specific employment records regarding FICA tax withholding and remittance in order to meet federal requirements. These records, which must be kept for every employee, include the amount of each payment subject to FICA taxes, the amount of FICA tax collected from each payment, along with the date, and an explanation for any difference between the amount subject to FICA taxes and the amount of tax collected.
Many small businesses fall behind in paying their FICA taxes or filing the associated reports at some time during their existence. A company struggling with cash flow may opt to pay suppliers and worker salaries in order to stay in business, rather than remitting its FICA tax withholdings on time. This is a very bad practice, however, because significant interest and penalties apply for late payment or nonpayment of FICA taxes. In fact, the Trust Fund Recovery Penalty allows the IRS to hold a small business owner or accountant personally liable for 100 percent of the amount owed, even in cases where the business has gone bankrupt. "Therefore, it is critical that owners and officers be aware of their liability if they are directly or indirectly responsible for withholding tax deposits," Carl Grassi wrote in Crain's Cleveland Business. "Those owners and officers taking a passive role within a business should remove themselves from the financial affairs to help ensure that they will not be made responsible for unremitted withholding taxes."
There are certain situations in which small businesses can avoid owing FICA taxes. For example, special rules apply to sole proprietorships and husband-and-wife partnerships that pay their minor (under 18) children for work performed in the business. These small businesses receive an exemption from withholding FICA taxes from their children's paychecks, and are also not required to pay the employer portion of the FICA taxes. In this way, the parent and child each save 7.65 percent, for a total of 15.3 percent. In addition, the child's wages can still be deducted from the parents' income taxes as a business expense.
There is no limit on how much children can earn and still receive the FICA tax exemption. However, it is important that the wages paid to the child are reasonable for the job performed, and that the hours worked by the child are carefully documented, so it will be clear to the IRS that the child has not been paid for nothing. In addition, parents should note that their child's financial aid for college may be reduced if they earn more than $1,750 per year.
Dailey, Frederick W. Tax Savvy for Small Business. Second Edition. Nolo Press, 1997.
DeJong, David S., and Ann Gray Jakabcin. J.K. Lasser's Year-Round Tax Strategies. Macmillan, 1997.
Glen, Heidi. "Young Americans Face Higher FICA Taxes or Lower Benefits." Tax Notes. 18 March 1996.
Grassi, Carl. "Federal Withholding Rules Enforced with an Iron Fist." Crain's Cleveland Business. 12 June 2000.
Marullo, Gloria Gibbs. "Hiring Your Child: Tax Breaks and Trade-Offs." Nation's Business. June 1997.