If you’ve ever looked at your earnings statement from a job, you have likely noticed some tax withholding. As part of your overall payroll taxes, the federal government requires employers to collect the FICA (Federal Insurance Contributions Act) tax. The FICA tax includes two separate taxes. Social Security taxes fund Social Security benefits and the Medicare tax goes to pay for the Medicare Hospital Insurance (HI) that you’ll get when you’re a senior. Below we’ll take a closer look at what Medicare taxes are and how they benefit you. And if you’d like the help of an expert one-on-one, head over to SmartAsset’s financial advisor matching tool to get paired up with a financial professional who can provide guidance tailored to your particular needs.
Medicare Taxes: The Basics
Like Social Security benefits, Medicare’s Hospital Insurance program is funded largely by employment taxes. If you work “under the table” you won’t pay into these systems. That’s why payroll tax withholding, although it takes a chunk out of your take-home pay, is actually providing you with something in return for those lost dollars in your paychecks.
Medicare HI taxes began in 1966, at a modest rate of 0.7%. Employers and employees were each responsible for paying 0.35%. Employees paid their share when their employers deducted it from their paychecks. Since 1966 the Medicare HI tax rate has risen, though it’s still below the Social Security tax rate. The current Social Security tax is 12.4% with employees and employers each paying 6.2%.
Today, the Medicare tax rate is 2.9%. Employers and employees split that cost with each paying 1.45%. Unlike with Social Security taxes, there is no limit on the income subject to Medicare taxes.
Medicare Taxes and the Affordable Care Act
The Affordable Care Act (ACA) added an extra Medicare tax for high earners. This surtax is known as the Additional Medicare Tax. As of January 2013, anyone with earned income of more than $200,000 ($250,000 for married couples filing jointly) has to pay an additional 0.9% in Medicare taxes beyond the standard 1.45%. That entire 0.9% is the responsibility of the employee. It is not split between the employer and the employee.
If your income means you’re subject to the Additional Medicare Tax, your Medicare tax rate is 2.35%. However, this Medicare surtax only applies to your income in excess of $200,000. If you make $250,000 a year, you’ll pay a 1.45% Medicare tax on the first $200,000, and 2.35% on the remaining $50,000.
Another result of ACA reforms is the Net Investment Income Tax (NIIT). The NIIT, also known as the Unearned Income Medicare Contribution Surtax, is a 3.8% Medicare tax that applies to investment income and to regular income over a certain threshold. If your Modified Adjusted Gross Income exceeds $200,000 ($250,000 if you’re married and filing jointly) you may be subject to the NIIT. Examples of investment income that is subject to the NIIT include dividends, interest, passive income, annuities, royalties and capital gains.
The 3.8% tax applies to the lesser of either your net investment income or the amount by which your MAGI exceeds $200,000 (or $250,000 for joint filers). That means the NIIT acts as either an extra income tax or an extra capital gains tax. You can report your net investment income on IRS Form 8690.
According to the IRS, a taxpayer may be subject to both the Additional Medicare Tax and the NIIT, but not necessarily on the same types of income. That’s because the 0.9 percent Additional Medicare Tax applies to wages, compensation and self-employment income over the $200,000 limit, but it does not apply to net investment income.
The combination of Social Security and Medicare tax rates, plus the income tax withheld from your paycheck, puts a serious dent in your take-home pay. Currently, the employee share of Social Security and Medicare taxes is 7.65%. If you make over $200,000, remember to account for the Additional Medicare Tax. It may seem like a lot of trouble now, but all this tax withholding is designed to give you a safety net when you reach retirement.
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