Types

• FICA is an umbrella term that includes two taxes: the Social Security tax and the Medicare tax. The Social Security tax, also known as old-age, survivors, and disability insurance, goes toward paying benefits to retirees and those who have suffered a permanent disability. The Medicare tax, also known as hospital insurance, goes toward paying for the costs of medical insurance for the elderly.
  
  

Function

• If you work as an employee, you split your FICA taxes with your employer. For example, in 2010 you pay 7.65 percent of your income in FICA taxes and your employer also pays a tax equal to 7.65 percent of your FICA taxes. Employees have the FICA taxes automatically withheld from their paychecks. If you are self-employed, you are responsible for paying the whole tax yourself. For example, in 2010, self-employed individuals pay a 15.3 percent FICA tax. This tax must be paid through estimated tax payments.
  
  

History

• FICA taxes were first introduced under President Franklin Roosevelt in 1937. At the time, only Social Security taxes were charged and the rate was 1 percent. Medicare taxes were not introduced until 1966. Originally, the FICA taxes hit employees harder than self-employed individuals. In 1937, both employers and employees paid 1 percent in FICA taxes each while self-employed individuals only paid 1 percent total. The rates for self-employed individuals started increasing relative to the rates for employees in 1951, but it wasn't until 1984 that self-employed individuals paid the same amount as employers and employees combined.
  
  

Considerations

• The Social Security tax may not apply to all of your income. As of 2010, only the first $106,800 of your earned income. This amount can change each year depending on inflation. If you have income from being an employee and being self-employed, your employee income counts toward the limit first. For example, if in 2010 you have $80,000 in employee income and $50,000 in self-employment income, you would pay the Social Security tax on the $80,000 of your employee income but only the first $26,800 of your self-employment income to reach the $106,800 limit.
  
  

Significance

• As you pay your Social Security tax, you earn work credits toward becoming eligible to receive Social Security benefits when you retire. As of 2010, you must have 40 retirement credits to receive benefits if you were born in 1929 or later. You can earn up to four credit per year. The more you have paid in taxes, the higher your monthly benefit will be when you retire.