If you’ve ever wondered, Do capital gains pay FICA?, you’re not alone. Many investors are unsure how taxes work when it comes to profits from selling stocks, real estate, or other investments. FICA taxes (Federal Insurance Contributions Act) are primarily used to fund Social Security and Medicare, but they apply specifically to earned income, like wages and salaries. So, do capital gains count as earned income, and are they subject to FICA? The short answer is no—capital gains are not considered wages and are therefore not subject to FICA taxes. However, before you start celebrating, it’s important to understand that capital gains are still taxed in other ways, such as through capital gains tax and potentially the Net Investment Income Tax (NIIT). In this article, we’ll explore why capital gains don’t pay FICA, what taxes you do need to pay on investment income, and how to minimize your tax burden legally and effectively.
What Is FICA, and What Does It Cover?
FICA is a payroll tax that funds Social Security and Medicare. It is automatically withheld from employee wages and consists of two components:
- Social Security Tax: 6.2% (up to the annual wage cap)
- Medicare Tax: 1.45% (with an additional 0.9% for high earners)
Self-employed individuals pay both the employee and employer portions through the Self-Employment Tax, totaling 15.3%. However, because FICA applies only to earned income (such as wages and self-employment income), capital gains do not fall under this category.
Why Capital Gains Are Not Subject to FICA?
Capital gains come from selling assets like stocks, real estate, and other investments at a profit. Since they are categorized as investment income rather than earned income, they are not subject to payroll taxes like FICA. Instead, capital gains are taxed separately under the capital gains tax system, which includes:
- Short-Term Capital Gains Tax: Applied to assets held for less than a year, taxed as ordinary income (10%-37%).
- Long-Term Capital Gains Tax: Applied to assets held for more than a year, taxed at lower rates (0%, 15%, or 20%, depending on income level).
The Net Investment Income Tax (NIIT) and Capital Gains
Although FICA does not apply to capital gains, high-income earners may still owe an additional Net Investment Income Tax (NIIT) of 3.8% on investment income, including capital gains. This tax applies to individuals with a modified adjusted gross income (MAGI) over:
- $200,000 (Single filers)
- $250,000 (Married filing jointly)
- $125,000 (Married filing separately)
If you exceed these thresholds, your capital gains may be subject to the NIIT, increasing your overall tax liability.
How to Legally Reduce Your Capital Gains Tax Burden?
While you can’t eliminate capital gains taxes entirely, you can minimize them using these strategies:
1. Hold Investments for Over a Year
Long-term capital gains are taxed at lower rates than short-term gains, so holding onto investments for more than a year can reduce your tax bill significantly.
2. Tax-Loss Harvesting
Offset capital gains by selling losing investments to reduce taxable income. This strategy allows you to deduct up to $3,000 in capital losses per year against other income.
3. Utilize Retirement Accounts
Investing in tax-advantaged accounts like IRAs and 401(k)s allows you to defer or avoid capital gains taxes.
4. Gift or Inherit Assets
Gifting appreciated assets to family members in lower tax brackets or holding investments until they receive a step-up in basis at death can help reduce taxes.
Conclusion: No FICA, But Still Taxed
To sum it up—capital gains do not pay FICA taxes because they are not considered earned income. However, that doesn’t mean they are tax-free. Capital gains are still subject to federal capital gains taxes, and for high-income earners, the Net Investment Income Tax (NIIT) can apply as well. Understanding how these taxes work can help investors plan effectively and keep more of their hard-earned profits.
FAQs
Are capital gains considered earned income?
No, capital gains are classified as investment income, not earned income, so they are not subject to FICA taxes.
Do I have to pay Social Security tax on capital gains?
No, Social Security tax (FICA) applies only to wages and self-employment income, not to capital gains.
What is the Net Investment Income Tax (NIIT), and does it apply to capital gains?
The NIIT is a 3.8% tax on investment income for high-income earners. It applies to capital gains if your modified adjusted gross income (MAGI) exceeds $200,000 (single) or $250,000 (married filing jointly).
How can I lower my capital gains taxes?
You can use strategies like holding investments for more than a year, tax-loss harvesting, investing in retirement accounts, and gifting assets to family members in lower tax brackets.
Are short-term and long-term capital gains taxed differently?
Yes. Short-term capital gains (held for less than a year) are taxed as ordinary income, while long-term capital gains (held for more than a year) are taxed at lower rates (0%, 15%, or 20%).