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  • Fullah Kamara

Understanding Employment Taxes: FICA and FUTA Explained

Employment taxes can often seem complex, but a basic understanding is crucial for both employers and employees. Let's dive into the two primary employment taxes: the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA), shedding light on their significance and workings.

1. FICA Taxes: A Dual Component System

a. Social Security Tax The Social Security Tax primarily caters to old age, survivors, and disability insurance. As of 2023, the rate for this tax is set at 6.2%. However, there's a cap on the income that can be subjected to this tax. For 2023, this cap is set at $160,200 (source:https://www.ssa.gov/oact/cola/cbb.html#:~:text=The%20OASDI%20tax%20rate%20for,for%20employees%20and%20employers%2C%20each.) , and it typically undergoes an annual adjustment.

b. Medicare Tax This component of FICA serves as hospital insurance. It is levied at a rate of 1.45% A distinguishing feature of the Medicare tax, in contrast to the Social Security Tax, is its lack of an income cap; all earned income is subject to this tax rate. Additionally, provisions in the Affordable Care Act impose an extra 0.9% tax on earned income exceeding $200k for single filers and $250k for those choosing to file joint married returns. For self-employed taxpayers, they might be subjected to a 12.4% rate for Social Security and 2.9% for Medicare, which includes the previously mentioned 0.9% tax. Furthermore, individuals with investment incomes face a 3.8% tax on their net investment income (Source: https://www.irs.gov/publications/p80#:~:text=Social%20security%20and%20Medicare%20tax%20for%202023.&text=The%20Medicare%20tax%20rate%20is,base%20limit%20for%20Medicare%20tax.).

2. FUTA Taxes: Ensuring Unemployment Benefits

FUTA's primary objective is to fund states in their administration of unemployment benefits. Its management is a joint effort between state and federal governments. This dual-management system necessitates that employers remain attentive to both sets of regulations.

Both state and federal returns are mandatory, with payments required for each governing entity. The Federal government allows credit for FUTA paid to the states. A crucial detail to keep in mind is that the credit is limited to 5.4% of the eligible wages (source: https://www.irs.gov/taxtopics/tc759). Consequently, businesses with low employee turnover may see their state rate decrease substantially, possibly to as low as 0.1% or even to zero. It's also important to highlight that FUTA is borne entirely by the employer; thus, employees won't observe any deductions for it on their paychecks.

Conclusion

The complex nature of employment taxes underscores the importance of understanding one's financial obligations, whether as an employer or an employee. By regularly revisiting the latest tax codes and seeking expert advice from professionals such as Certified Public Accountants (CPAs), Enrolled Agents, or Tax Attorneys when necessary, individuals and businesses can ensure compliance and sound financial planning.

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