Medicare Tax

Medicare tax is a federal payroll tax that helps pay for the Medicare program.

The Medicare tax is generally withheld from your paycheck as part of your FICA (Federal Insurance Contributions Act) taxes — what are usually called “payroll taxes.” FICA taxes include money taken out to pay for older Americans’ Social Security and Medicare benefits.

If you are self-employed, your Medicare taxes are included in your self-employment tax.

Medicare tax is paid by taxpayers to specifically fund Medicare Part A hospital insurance, which offers coverage for hospital inpatient care, skilled nursing facility care, hospice care and certain types of home health care for individuals enrolled in Medicare.

The Medicare tax rate is 2.9% of your income. If you work for an employer, you pay half of it and your employer pays the other half — 1.45% of your wages each.

If you are self-employed, you are responsible for the full 2.9%.

Your total FICA tax rate equals 15.3% of your wages — with the other 12.4% of your salary going to Social Security. Your employer also pays half of the Social Security taxes.

People with higher incomes may also have to pay an additional Medicare tax of 0.9% to help pay for the Affordable Care Act.

The answer is yes, Medicare does have surtaxes. A surtax is an additional tax imposed by the government on something already taxed. Typically, a surtax is charged on taxpayer incomes higher than a certain level at which normal income tax is paid. It can be calculated as a percentage of a certain amount or a flat dollar rate.

Surtaxes were originally introduced in 1967, when President Lyndon B. Johnson proposed a 6% surcharge on corporate and individual income taxes. However, it did not take effect until ten months later in 1968 when it was signed into law in the Revenue and Expenditure Control Act of 1968.

The Act provided a surcharge of 10% on federal corporate income taxes and personal income taxes as a measure to reduce the U.S. budget deficits and support the funding activity for the Vietnam War. Charging higher taxes would reduce the amount of money available for spending abroad to maintain the worldwide competitive position of U.S. goods.

The Affordable Care Act added an extra Medicare surtax for people with higher incomes starting in January 2013.

Named the Additional Medicare Tax, it adds an additional 0.9% tax on top of the 1.45% employees have to pay. Employers are not required to match the amount and the employee is responsible for the entire amount of the extra tax.

Whether you have to pay the Additional Medicare Tax depends on your annual income and your tax filing status. You only owe the additional 0.9% Medicare tax on the money you earn over and above $200,000.

Once you exceed the threshold listed above, you are responsible for the additional tax.

Let’s say you have a single tax filing status. You don’t pay the additional 0.9% tax on the first $200,000 you earn in a year. You will pay the standard 1.45% and your employer will pay a matching 1.45%.

But if you earn more than $200,000 a year, your employer will withhold a 0.9% additional Medicare tax. So, your total Medicare tax will equal 2.35% of your salary on everything you earn over $200,000.

Remember, the tax is not withheld until you cross the $200,000 threshold. The additional tax will then be withheld until the end of the calendar year. Your employer does not match this additional tax.

Let’s say you are married and filing jointly. You earn $175,000 and your spouse earns $100,000, bringing your combined income to $275,000. Since your combined income is above the $250,000 threshold, you’ll be liable for the additional 0.9% Medicare tax.

However, because you and your spouse’s wages individually were less than $200,000, your employers will not withhold the additional tax. To ensure that enough taxes are withheld, you should make estimated tax payments or request additional withholdings on form W-4.

Net Investment Income Tax (NIIT), also known as unearned income Medicare contribution surtax, is an additional 3.8% tax applied to net investment income. The tax is applied to the lesser of an individual’s net investment income or the amount by which the modified adjusted gross income (MAGI) exceeds a certain threshold.

As of the current tax year, the NIIT threshold for single filers is $200,000 ($250,000 for married couples).

Net investment income includes interest, dividends, non-qualified annuities, capital gains, royalties and rental income. It does not include income derived from wages, social security benefits, alimony, unemployment compensation and most self-employment.

For example, let’s say you are a single taxpayer who makes $150,000 in wages during the year and experienced a one-time capital gain of $90,000 from selling long-term stocks. This would increase your total income to $240,000. In this case, the investment income amount above the threshold ($40,000) is subject to the 3.8% surtax. You would owe a NIIT of $1,520 (40,000 x 3.8%).

All employees, employers and self-employed workers in the United States, regardless of citizenship or residency status, must pay Medicare taxes to fund the Medicare Hospital Insurance program.

By law, in accordance with FICA, employers are required to withhold Medicare tax and Social Security tax from every paycheck and submit them to the government or face significant penalties.

The Medicare tax funds are used to pay for Medicare Part A, which provides hospital insurance for the elderly and people with disabilities.

Through employment payroll tax withholdings, Medicare tax funds accumulate in the system for later use. The tax revenues are added to the Hospital Insurance (HI) Trust Fund which finances health care services related to stays in hospitals, skilled nursing facilities and hospices for mainly people over age 65 with a sufficient history of Medicare contributions. It also pays for administering the Medicare program and covering the costs of fighting Medicare fraud and abuse.

By paying this tax while you are working, you are funding the services you may encounter once you become a Medicare beneficiary.

However, if someone is working under the table and not paying into these systems, they will be without Medicare funds to cover future hospital care.

Generally, you will find that not all wages or incomes are subject to Medicare taxes. Understanding which wages are subject to tax versus the ones that aren’t will ensure that you are accurately paying taxes.

If you are self-employed, you are responsible for the entire 2.9% share of your earned income for the Medicare tax. This is covered through a self-employment (SE) tax. The self-employment tax covers your entire 15.3% of FICA taxes, paying your share of Social Security and Medicare taxes.

However, you may get a break.

You determine your SE tax using the IRS Schedule SE on either Form 1040 or 1040-SR. You may then deduct the employer-equivalent amount of your self-employed tax — half of the total amount — from your gross income.