Is it legal for a company to deduct their FICA match from a W2 employee's pay?

Question

I'm considering a new job. One company proposes I work for them (Company AA: a US-based professional services org) under their contract with a US-based Fortune 500 company (Company ZZ). The contract employment terms that company AA and I have discussed are either:

• On 1099 C2C (I would have to create a company)
• On W2

I'm not so interested in the 1099 proposal. Thus, I ask this question from the perspective of a US-based W2 contract employee with Company AA.

As a W2 employee, I believe the IRS requires employers to split the total FICA Social Security and Medicare burden 50/50; the W2 Employee pays 50% and the Employer pays 50% of the total.

While discussing compensation, an employee of Company AA showed me a spreadsheet with the following terms:

• Deduct FICA Employee Social Security from my pay
• Deduct FICA Employee Medicare from my pay
• Deduct FICA Employer Social Security match from my pay
• Deduct FICA Employer Medicare match from my pay

I don't think they are truly "matching" my FICA Employee deduction if they withdraw the Employer side of the FICA contributions from the Employee pay.

The question is whether deducting W2 FICA Employer match is legal from the IRS' perspective.

Answer 1

If you're a 1099 contractor, you're considered self-employed. You'd be responsible for both the employer and employee portion of Social Security and Medicare taxes (this is SECA for self-employed people, rather than FICA, but they're essentially the same). But, the company wouldn't take it out of your pay. In fact, the company wouldn't withhold any income taxes from you at all.

However, many people who contract through an agency are paid as W-2 employees by the agency (not the company they're doing contract work for). In that case, you're an employee and your employer would withhold your half of FICA from your pay, and be responsible for their half (they can't take the employer's portion out of your pay).

Two exceptions to the above:

Statutory employees are 1099 workers, but are treated as employees. They have FICA withheld from their pay as if they're W-2 employees (income taxes are not withheld), are not considered self-employed, and are only responsible for the employee's share of FICA.

Statutory nonemployees are W-2 workers, but are treated as independent contractors. They do not have taxes withheld from their pay, are considered self-employed, and are responsible for both the employee and employer shares of FICA (or SECA, for self-employed people).

In no case is the company you contract for or the agency you're employed by allowed to withhold the employer's portion of FICA from your pay.

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Additions based on edits to the OP:

The company is (barring any local laws prohibiting this) allowed to change pay rates depending on whether you're paid as a non-employee (1099-NEC) or employee (W-2). If they've framed it as "we will pay you less because we have to pay more in taxes and benefits", that's fine (again, barring laws prohibiting it). If they are literally forcing you to pay their share of FICA, that's not allowed.

This wasn't part of the question, but strongly consider what you gain/give up by choosing to be either a non-employee 1099 contractor vs. a W-2 employee. Benefits, employee protections, flexibility, taxes, expenses, reimbursements, etc. There are likely differences between the two roles (job description, contractor/employment contract, what is required and prohibited of you, etc.) since is it not legal to classify an employee as an independent contractor. There are hefty penalties for it (well, maybe not too hefty for a big company).

Answer 2

They can't legally deduct both parts of FICA and Medicare. What is supposed to happen is that you get 7.65% deducted from your pay and, independently, the employer pays an additional 7.65%. The employer pays 15.3% total. For example:

• You earn $100
• You receive $100 - 7.65% = $92.35 (there may be other deductions for Federal tax, state tax or other things but we'll ignore those for now)
• Employer pays $15.30 to the IRS.

However, what an employer might try to do is:

• Pay you $92.90
• You receive $92.90 - 7.65% ($7.10) = $85.80
• Employer pays $14.20 to the IRS

Thus the employer is out of pocket only $100. But you only net $85.80 instead of $92.35. The IRS, as always, gets what it is supposed to get.

If an employer did this without your knowledge (i.e., told you they were paying you "$100 less FICA/Medicare" and then paid you only $85.80) that would certainly be illegal. If you were being paid minimum wage or very close to it such that you were now paid less than minimum wage (based on your gross wages, not net wages, so $100 vs. $92.90 here, not $85.80) then that would also be illegal. However, if you agreed to this scheme then it would simply be negotiated wages that would be arguably unfair but probably not illegal.

To me, this sounds very similar to the idea of a merchant "paying your sales tax". They can't (at least in some places, as I understand it) actually pay the sales tax for you. But they can lower the retail price such that the price with tax added as normal matches what the original price would have been without adding tax. As in, with a 6% tax rate:

• Original cost $100, which is $106 with tax.
• Set the cost instead at $94.34. Add the tax to get $100 (ignore the rounding error fraction of a penny). Have you pay $100.

You now paid "without tax". Except really you didn't. They just finagled the numbers to make it work as if there was no tax.

Answer 3

The question is whether this is legal from the IRS' perspective

It is not. These are taxes on the employer, you pay your own taxes. You can report them to the IRS following the instructions here. You're not supposed to be paying employer's taxes.

Answer 4

As I understand this question (and others have understood it differently) you are switching from a contractor to an employee and the question is how to compute what your salary as an employee should be based on what you were previously paid as a contractor.

This should take into account all of the differences between a contractor and an employee. And the IRS doesn't care -- you can agree to whatever salary both of you find acceptible as either an employer or a contractor. This is about finding a fair balance.

Here are some factors to take into account:

1. A contractor does not usually get any benefits such as health care, unemployment, paid sick days, or paid time off. As an employee, your salary should be less by the value of these benefits you will get.

2. A contractor must pay their full FICA costs. An employee has half of their FICA costs paid by their employer. Thus your employee salary should be less by the value of these taxes that will now be paid by your employer instead of you.

3. A contractor is supposed to be free to choose how they do their work and when they work. An employee is under their employer's control. If this actually applies to your situation, you should adjust as appropriate.

4. A contractor is supposed to provide their own tools and bear many of their own costs of operating. An employee is supposed to have these costs covered by their employer. If this applies to your situation, you should adjust as appropriate.

5. A contractor has various tax deductions available to them that are not available to an employee. This should be taken into account.

6. An employee generally has a guaranteed salary or guaranteed hours. A contractor generally is used as needed. If this applies to you, it should be taken into account.

Answer 5

This really looks like an XY Problem where we are fussing about a tax issue that does not really exist. The real issue is understanding the implications of working 1099 vs W2 and looking at the numbers from the perspective of the worker vs the person hiring. There are several rates we need to keep in mind:

Fully Burdened Rate: This is the hourly rate charged to the end customer if they are paying for you hourly. It is usually feels crazy high because it includes the costs of all the other people in the company you are paying for it is not unusual for it to be a significant multiple of the 1099 rate. In this example lets say it is $250/hour.

Hourly Labor Cost: This is what the person hiring you is working from, it is the budget for what they are willing to pay for the position they are hiring you for. This is how much it costs the contracting company for each hour you work. In our example we could say this is $110/hour.

1099 Rate: In this case all employment expenses are being passed onto you as the worker. There might still be some small admin costs but this is basically the maximal hourly payment you will get. In this case it would be $100/hour.

W2 Rate: As a W2 employee you have significantly more costs associated with you on the company side. This includes taxes payed by the employer like the original question was asking about as well as amortized PTO time, health insurance, 401k, and such. It can be significant in an example from my past this number would look like $58/hour in this example.

Given all that setup we can finally talk about what is going on in this question. First off, the number you are actually negotiating is the hourly labor cost and the manager/hr person/whoever you are negotiating with only cares about that. Normally you don't get to see that number, and in this situation you got a glimpse behind the curtain and saw how they calculate the W2 rate they will pay to match that number.

The relation between 1099 and W2 rates are a function of benefits and company structures so the percentages will very from gig to gig. One gig I took the employer had to pay their part of the health insurance regardless of if I used it. That made the W2 rate much less attractive compared to the 1099 rate. I have also been able to negotiate a higher W2 rate because my wife has great insurance so I could guarantee that I would not use theirs. That employer contribution that was part of the hourly labor cost was then eliminated, and they could give me more money without changing the number they actually cared about.

In this question I really don't believe anything nefarious was going on. You just got to see the labor cost calculations they were building your offer off of. That said you can totally get taken advantage of if you don't know how all the parts interact.

I would strongly suggest that you go into the next negotiation with your own spreadsheet that converts the W2 and 1099 rates on offer into effective dollars in your pocket. There are lots of calculators online that can give you a feel for what to include, in the end you need to use the model that matches your situation.

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Edit: The OP is very convinced that this is not an XY problem so I will directly address his comment below:

This answer is a bucket full of red herrings. Again, my question was: whether deducting W2 FICA Employer match (from my pay) is legal from the IRS' perspective. I don't see an answer here.

The answer is that "it depends" and "your accountants will hate you." Generally, your employer can deduct any sort of fees you agree to in your contract; so, the starting point is that you are free to contract and work under those terms.

There are knock on effects that would make it illegal, for instance using this as a way to pay less than minimum wage would not be legal. Not informing you about it or retroactively imposing this as a policy would be illegal.

The accounting implications are also significant, this is just a scheme to give the government more tax money. Lets say you make $100 in a normal W2 situation. You are costing the company $107.65 with their FICA contribution and they are sending $15.30 to Uncle Sam. If you move that $7.65 into your pay then the taxed amount is not $100 but $107.65, so government would get $16.47. That also now means there is still an "unpaid" employer contribution left of $1.17 which if you iterate converges with a total cost of $16.68.

I did that math assuming the employer would be increasing your wage to cover their contribution for simplicity, I am sure it would be going the other way. Regardless, by paying you and then charging you the employer contribution the end result will be a FICA tax bill that is about 1.3% higher.

The other bit of tax implication is that normally the employer portion of FICA is not taxed. But now you will also be taxed on that as income with effectively reduces your income by 7.65 times your marginal rate (say 22%) so that will also increase your taxes by another 1.7% or so.

This scheme results in a tax bill that is $3 more an hour, is non-standard, and complex. To bring this topic full circle this is why I think you asking an XY-problem type question, the way you are suggesting you are being cheated doesn't make any sense financially. It does make perfect sense however if you are looking at the way the company calculates equivalent cost 1099 vs W2 rates.

Summary: Not illegal when negotiated as part of your contract while being financially counterproductive and generally dumb.