Under the Patient Protection and Affordable Care Act, workers earning more than $200,000 a year ($250,000 for joint filers) must pay higher Medicare hospital insurance (HI) taxes beginning in 2013. The new tax is 2.35% (an increase of 0.9%) of applicable wages above those thresholds, so a worker earning $300,000 a year will pay HI taxes of 1.45% on $200,000 plus 2.35% on $100,000. There is no change to the employer’s share of the HI tax.

Also starting in 2013, high-income taxpayers will be subject to a new Medicare tax on investment income, such as capital gains, dividends, interest and rental income. The tax will be 3.8% on the lesser of:

  • The individual’s net investment income
  • Any excess of an individual’s modified adjusted gross income over specified threshold amounts (also $200,000 for individuals and $250,000 for joint filers)

The 3.8% Medicare tax also applies similarly to some estates and trusts. Employers have no withholding or payment obligation for the 3.8% Medicare tax on unearned income.

The new HI tax for high-wage earners will raise roughly $87 billion over 10 years, and the Medicare tax on net investment income is expected to raise an additional $123 billion over 10 years, according to the Congressional Research Service Report for Congress. The Medicare taxes are intended to help pay for health insurance subsidies.

Employer and taxpayer responsibilities

Employers must withhold the additional 0.9% Medicare HI payroll tax (Form W-2, box 5) regardless of the employee’s tax filing status or marital status. Payroll departments and vendors will need to make the necessary administrative adjustments to comply.

As employers will calculate the additional 0.9% Medicare HI payroll tax based on the employee’s income (Figure 1), a married couple’s combined income could exceed the $250,000 threshold even though their respective employers did not withhold the tax. These couples will be responsible for filing and paying the additional tax themselves on their Form 1040.

Figure 1. Threshold amounts for higher Medicare taxes

Filing status

Threshold

Married filing jointly

$250,000

Married filing separately

$125,000

Single

$200,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$200,000

Source: Internal Revenue Service.

Although employers are not directly involved with the new 3.8% Medicare tax on investment income (taxpayers must report and pay the tax on their Form 1040 income tax return), some might wish to inform employees about it.

Employers might also want to suggest tax planning strategies for the new HI taxes on earnings and investment income, such as accelerating the FICA taxation of supplemental executive retirement benefits into 2012 using early inclusion or accelerating a 2013 bonus payment into 2012.

IRS frequently asked questions

The Internal Revenue Service (IRS) has issued frequently asked questions (FAQs) about the increased Medicare HI payroll tax, providing basic information such as timelines, tax rates and wage thresholds, as well as guidance for employers and payroll service providers on administrative issues. 

The FAQs include (but are not limited to) the following answers/information:

  • The wages earned by nonresident aliens and U.S. citizens living abroad that are subject to Medicare tax are also subject to the additional Medicare tax withholding.
  • Employers are not required to notify employees when they begin withholding the additional Medicare tax.
  • Employees cannot request additional withholding specifically for the additional Medicare tax, although they can request additional income tax withholding on Form W-4.
  • Employers must begin withholding the additional Medicare tax in the first pay period in which wages exceed $200,000.
  • Employers should include the following in determining wages for the additional Medicare tax:
    • Noncash compensation (i.e., compensation paid in noncash fringe benefits)
    • Reported tips: If the employee does not receive enough wages for the employer to withhold all the taxes owed, the employee may give the employer money to pay the rest of the taxes.
    • Nonqualified deferred compensation (NQDC): The special timing rule for the regular Medicare tax also applies to withholding for the additional Medicare tax. In general, employers should withhold Medicare taxes as soon as the deferred compensation is “reasonably ascertainable.”
  • Imputed income on group-term life insurance amounts greater than $50,000 counts toward the Medicare wage thresholds. If employees or retirees receive group-term life insurance worth over $50,000 after terminating employment, the employee pays the employee’s share of these taxes on his or her tax return; the employer does not collect these taxes. However, employers must report this income as wages on Form 941, Employer’s Quarterly Federal Tax Return, and make a current period adjustment to reflect any uncollected taxes on the group-term life insurance.
  • Wages paid by an employer and by a third-party payer of sick pay must be aggregated to calculate wages for withholding threshold purposes. The same rules that currently assign responsibility for sick pay reporting and payment of Medicare taxes based on which party is treated as the employer also apply to the additional Medicare tax.
  • If an employee performs services for multiple subsidiaries of a company, and each subsidiary is his or her employer for the services performed for that subsidiary, the wages paid on behalf of each subsidiary should be combined only if the payer is a common paymaster.
  • If an employee works for two separate employers and the same payroll agent works for both employers, the agent should not combine the wages in calculating wages for withholding threshold purposes.
  • The IRS plans to release drafts of relevant revised tax forms.

Contact:
Kathleen Rosenow
+1 507 358 0688
kathleen.rosenow@towerswatson.com