Higher Medicare Payroll Tax on Wages and Self-employment Income

The Medicare payroll tax is the primary source of financing for Medicare, which pays hospital bills for individuals who are 65 or older or disabled.  Wages paid through December 31, 2012, are subject to a 2.9% Medicare payroll tax.  Workers and employers pay 1.45% each.  Self-employed individuals pay both halves of the tax, but are allowed to deduct the employer-equivalent portion (i.e., 1.45%) for income tax purposes.  Unlike the payroll tax for social security purposes, which applies to earnings up to an annual ceiling ($113,700 for 2013), the Medicare tax is levied on all of an employee’s wages subject to FICA taxes.

Beginning in 2013, individuals who have wage and/or self-employment income exceeding $200,000 ($250,000 if married, filing a joint return; $125,000 if married, filing separately) are subject to an additional 0.9% Medicare tax (i.e., 2.35% total) on their earned income exceeding the applicable threshold.  The employer portion of the Medicare tax is not increased.  However, employers are required to withhold and remit the additional tax for any employee to whom it pays over $200,000.  Companies are not responsible for determining whether a worker’s combined income with his or her spouse makes the employee subject to the additional tax.  Therefore, many individuals (especially those who are married with each earning less than $200,000, but earned more than $250,000 combined) should consider adjusting their federal income tax withholding (FITW) by submitting a new Form W-4 to the employer or making quarterly estimated tax payments to be sure they are not hit with an underpayment penalty when filing their income tax return each year.

Self-employed individuals who pay both halves of the Medicare tax (i.e., 2.9%) will pay a total Medicare tax of 3.8% on earnings above the thresholds.  The additional 0.9% tax is not deductible for income tax purposes.  Self-employed individuals should consider adjusting their quarterly estimated income tax payments to account for this additional tax.

Married couples with combined incomes approaching $250,000 should keep tabs on their total earnings to avoid an unexpected tax bill when filing their individual income tax return.  At this time, the threshold amounts ($200,000/$250,000) are not adjusted for inflation.  Therefore, it is likely that increasingly more people will be subject to the higher payroll taxes in coming years.