Lesson 1.4 · Unit 1 · N-Q.3

The taxes taken from every dollar you earn

Income tax is paid on what remains after a standard amount is excluded, but payroll taxes are taken from the first dollar of wages. They fund Social Security and Medicare, they are paid by the employee and the employer in equal parts, and one of them stops at a ceiling while the other does not.

The method
  1. Social Security tax is 6.2 percent of wages paid by the employee, and the employer pays another 6.2 percent.
  2. Medicare tax is 1.45 percent of wages paid by the employee, and the employer pays another 1.45 percent.
  3. Together they are called FICA, for a combined 7.65 percent from each side, 15.3 percent in all.
  4. Social Security has a wage base: wages above a ceiling are not taxed for it. The ceiling changes every year. This course uses \$170,000 for all problems.
  5. Medicare has no ceiling. An additional 0.9 percent Medicare tax, paid by the employee only, applies to wages above \$200,000.
  6. The taxes begin with the first dollar. There is no standard deduction that shields low wages from them.
  7. The employer's cost of an employee is the wages plus the employer's half, so it exceeds the wages by 7.65 percent even before any benefits.
  8. In a year when wages cross the wage base, Social Security tax stops in the pay period where the total reaches the base, and that check is taxed only on the part of the wages below it.

Where students lose marks: applying the Social Security ceiling to Medicare. The ceiling applies only to the 6.2 percent tax. A high earner's Medicare tax keeps going on every dollar, and the highest earners pay more of it.

Worked example

The problem. An employee earns \$180,000 a year, paid monthly at \$15,000. The Social Security wage base is \$170,000. (a) Find the Social Security and Medicare tax in the first month. (b) Find the tax in the twelfth month. (c) Find the total employee FICA for the year. (d) Find the total the employer pays.

Step one: name the givens. Wages are \$15,000 a month. Social Security is 6.2 percent to a ceiling of \$170,000. Medicare is 1.45 percent with no ceiling.

Step two: first month for (a). Social Security: \( 0.062 \times 15000 = 930.00 \). Medicare: \( 0.0145 \times 15000 = 217.50 \).

Step three: find where the ceiling is reached. Eleven months of wages is \( 11 \times 15000 = 165000 \), which is under \$170,000. The twelfth month takes the total past the ceiling, so only \( 170000 - 165000 = 5000 \) of that month's wages is subject to Social Security.

Step four: twelfth month for (b). Social Security: \( 0.062 \times 5000 = 310.00 \). Medicare still applies to the whole \$15,000: \( 0.0145 \times 15000 = 217.50 \).

Step five: annual Social Security for (c). Over the whole year only the first \$170,000 is taxed: \( 0.062 \times 170000 = 10{,}540.00 \). Check: eleven months at \$930 is \$10,230, plus \$310, is \$10,540.

Step six: annual Medicare. \( 0.0145 \times 180000 = 2{,}610.00 \). The wages are below \$200,000, so there is no additional tax.

Step seven: employee total. \( 10540 + 2610 = 13{,}150.00 \). The employee's take-home is reduced by this, before income tax.

Step eight: employer total for (d). The employer pays an equal amount, \$13,150.00, so the employee's true cost to the employer is \( 180000 + 13150 = 193{,}150 \) dollars. The tax on the employee's paycheck is only half of the tax on the employee's work.

Practice · 10 problems

Problems 1 to 5 are routine. Problems 6 to 10 are multi-step or ask for reasoning. Use the \$170,000 Social Security wage base.

  1. Find the Social Security and Medicare tax on a \$2,000.00 paycheck.
    Show the full solution

    Social Security: \( 0.062 \times 2000 = 124.00 \). Medicare: \( 0.0145 \times 2000 = 29.00 \). \$124.00 and \$29.00

  2. Find the Social Security and Medicare tax on a \$1,640.00 paycheck.
    Show the full solution

    Social Security: \( 0.062 \times 1640 = 101.68 \). Medicare: \( 0.0145 \times 1640 = 23.78 \). \$101.68 and \$23.78

  3. Find the combined FICA tax from the employee on a \$3,200.00 check.
    Show the full solution

    The combined rate is \( 6.2 + 1.45 = 7.65 \) percent, and \( 0.0765 \times 3200 = 244.80 \). \$244.80

  4. An employee is paid \$60,000 a year. Find the employer's total cost for wages and the employer's half of FICA.
    Show the full solution

    The employer's half is \( 0.0765 \times 60000 = 4590 \). The total is \( 60000 + 4590 = 64590 \). \$64,590.00

  5. An employee earns \$120,000 in a year. Find the annual Social Security tax.
    Show the full solution

    The wages are below the \$170,000 base, so all of them are taxed: \( 0.062 \times 120000 = 7440 \). \$7,440.00

  6. A worker is paid \$2,400.00 a week. Find the Social Security and Medicare tax on one check.
    Show the full solution

    Social Security: \( 0.062 \times 2400 = 148.80 \). Medicare: \( 0.0145 \times 2400 = 34.80 \). \$148.80 and \$34.80

  7. A worker is paid \$3,400 a week. In which week does cumulative pay first reach the \$170,000 Social Security base?
    Show the full solution

    The number of checks needed is \( \dfrac{170000}{3400} = 50 \). Fifty checks total exactly \$170,000, so the ceiling is reached in week 50. Checks 51 and 52 pay no Social Security tax, and their Medicare tax continues. Week 50

  8. A single employee earns \$250,000. Find the annual Medicare tax including the additional 0.9 percent on wages over \$200,000.
    Show the full solution

    The basic tax is \( 0.0145 \times 250000 = 3625 \). The additional tax applies to \( 250000 - 200000 = 50000 \): \( 0.009 \times 50000 = 450 \). Total \( 3625 + 450 = 4075 \). \$4,075.00

  9. An employee earning \$190,000 a year says her Social Security tax is \( 0.062 \times 190000 = 11{,}780 \). Find the error and the correct tax, and find her Medicare tax.
    Show the full solution

    Only the first \$170,000 of wages is subject to Social Security. The correct tax is \( 0.062 \times 170000 = 10{,}540 \). Medicare has no ceiling: \( 0.0145 \times 190000 = 2{,}755 \). Her wages are below \$200,000, so there is no additional Medicare tax. \$10,540.00 Social Security; \$2,755.00 Medicare

  10. A student says, "My employer pays half of FICA, so it costs me nothing." Explain in terms of total compensation.
    Show the full solution

    The employer's half is part of what the employer spends to employ the worker, so the money could have been paid as wages. On a \$60,000 salary the employer's half is \$4,590. The employee does not see it on the pay stub, but the cost to hire is \$64,590, and the employee's compensation is effectively larger than the stub shows. The tax also buys the employee's future Social Security and Medicare benefits. It is a real cost of the job, even though it is not on the stub

← 1.3 Reading a pay stub: from gross to net1.5 Percent change, raises and comparing offers →

Keep going in the full Financial Algebra course

All of U1 (Unit 1: Earning and Paychecks) is free to everyone, with no account. The course has 75 lessons, each with worked examples and practice problems that come with full solutions. A free account can also start a free month of the whole course, with no card.

Open this lesson in the courseSee the whole course