FICA Tax Update. New Rules Take Effect January 1, 2017 - What You Need to Know
Posted on December 12, 2016 by Jessica Miller in Compensation

FICA Tax Update- What You Need to Know. Remember, new FICA Laws Take Effect January 1, 2017.

FICA Tax Update- What You Need to Know
Read full, detailed article. 

Watch the short, easy-to-understand video below or link to it on YouTube.  

By now, you’ve probably heard that starting next year there is a new way that FICA tax is to be calculated. FICA stands for Federal Insurance Contributions Act (FICA) and is two separate taxes- Social Security and Medicare.  This tax is paid by all legal wage earners for the purposes of providing benefits for retire or in the event of a disability.

In 2014, Kentucky was facing compliance issues related to the way that the state had been collecting FICA. Kentucky had been using the following formula: Total Wages less the Employee’s Pension Contributions = Taxable FICA Wages.  Unfortunately, this is not the correct formula for calculating tax liability because it does not include the employee’s pension contributions in taxable wages. To understand how this error happened, we have to look at a bit of history.

In 1974, Congress added section 414(h) to the U.S. Internal Revenue Code, which provided a tax break to governmental employers by removing state pension contributions from an employee’s gross income until such time they were distributed by pension systems.   The legislation exempted these payments if the employer deducted and paid the pension contributions directly to the retirement system, or “picked up” the contributions.  As a result of Section 414(h), many governmental employers opted to “pick up” the contributions of their employees for the tax benefit. In 1983, after noticing the trend, Congress added a provision to the Code that clarified that any “picked up” amounts would be treated as employer contributions under 414(h)(2) and thus treated as FICA wages subject to FICA taxes.

From 1983 until 2014, Kentucky governmental employers continued to use the calculation that exempted pension contributions.  In 2014, IRS officials told state officials that the calculation was no longer valid and that employee pension contributions had to be included for calculating FICA tax liability.

So what does this mean for your city?

  • No past liability is owed by any governmental entity in Kentucky.
  • The new FICA calculation will be effective January 1, 2017.  As of that date, taxable FICA wages will include the employees’ pension contributions.
  • Prior to the effective date, your city should be working to plan for this change by implementing a plan for the increased expense in your budgeting process for personnel costs. You will also want to make any necessary changes in your payroll system to correct the FICA calculation. Also, make sure to communicate the changes to all impacted employees. This brief video can help you communicate this change to your employees. Please share the link to help spread this information.

If you have questions or need additional information, please contact KLC Member Legal Services at 1-800-876-4552.