What Are Medicare Taxes?

Medicare taxes are payroll taxes that fund the federal health insurance program for people 65 and older, as well as certain younger individuals with disabilities. Workers and employers each pay a percentage of wages toward Medicare, while high-income earners may owe an additional surtax on earnings above set thresholds. These taxes help cover hospital care and other healthcare services provided through Medicare.

A financial advisor can help you plan and save for future medical expenses. Connect with a fiduciary advisor for free.

What Is Medicare?

Medicare is a federal health insurance program primarily designed for people age 65 and older. It also covers certain younger individuals with disabilities and those with specific medical conditions. The program helps reduce health care costs by covering many essential medical services.

Medicare is funded through a combination of payroll taxes, premiums and general federal revenue. Medicare taxes collected from workers and employers play a major role in financing the program. These taxes help ensure that benefits are available for current and future beneficiaries.

Medicare plays a critical role in retirement planning and health care security. Health care expenses can be one of the largest costs in retirement, and Medicare helps manage those expenses. Understanding how Medicare works provides important context for why Medicare taxes exist and how they support long-term health coverage.

Medicare Tax Basics

Medicare’s Hospital Insurance program is funded through payroll taxes collected from workers and employers. These taxes support Medicare Part A, which covers services like inpatient hospital care, skilled nursing facility stays and certain home health services. When wages are paid off the books, neither the worker nor the employer contributes to this system, which reduces future access to earned Medicare benefits.

Medicare HI taxes were first collected in 1966 at a combined rate of 0.7%, with workers and employers each covering 0.35% of wages. The rate has increased over time as the program expanded and healthcare costs rose, though it remains lower than the Social Security payroll tax. For comparison, Social Security taxes total 12.4%, split evenly between employers and employees.

The current Medicare payroll tax rate is 2.9%, with employees and employers each paying 1.45%. And unlike Social Security taxes, which apply only up to an annual wage cap, Medicare taxes apply to all earned income with no upper limit.

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 (for single filers). 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.

Net Investment Income Tax (NIIT)

Another result of ACA reforms is the net investment income tax (NIIT), also known as the unearned income Medicare contribution surtax. The NIIT is a 3.8% tax that applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds the applicable threshold.

If your modified adjusted gross income exceeds $200,000 ($250,000 for married couples filing jointly), you may be subject to the net investment income tax if you have qualifying investment income. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds the threshold. Investment income that may be subject to the NIIT includes dividends, interest, capital gains, passive income, annuities and royalties.

The 3.8% tax applies to thelesser of either your net investment income or the amount by which your MAGI exceeds $200,000 ($250,000 for joint filers or $125,000 for married filing separately). You can report your net investment income on IRS Form 8960 ¹ .

According to the IRS, a taxpayer may be subject to both the Additional Medicare Tax and the NIIT, but they apply to different types of income. The 0.9% Additional Medicare Tax applies to earned income, such as wages, compensation and self-employment income above the applicable threshold, while the NIIT applies only to unearned income, such as investment income.

How Medicare Taxes Apply to Self-Employed Workers

People who work for themselves pay Medicare taxes through the self-employment tax system instead of payroll withholding. Because there is no employer involved, the individual covers the full Medicare tax tied to their business or freelance income.

For self-employed income, the Medicare tax rate is 2.9% of net earnings. This reflects both halves of the tax that wage earners split with an employer. As with employee wages, there is no upper income limit on earnings subject to the Medicare portion of the tax.

Self-employed taxpayers with higher income may also owe the Additional Medicare Tax. When net self-employment income exceeds $200,000 for single filers or $250,000 for married couples filing jointly, an extra 0.9% applies to the amount above those thresholds. This surtax applies only to earned income, not investment income.

Medicare taxes for self-employed individuals are calculated using Schedule SE and included with the annual federal tax return. Since taxes are not withheld during the year, many self-employed workers pay estimated taxes quarterly to account for income and Medicare tax liability.

While self-employed taxpayers may deduct the employer-equivalent portion of the self-employment tax when calculating adjusted gross income, this deduction does not reduce the Medicare tax itself. The full Medicare tax is still paid and credited toward future Medicare coverage.

Bottom Line

Medicare is a cornerstone of the U.S. health care system, providing essential coverage for millions of retirees and individuals with disabilities. Medicare taxes collected during your working years help fund this coverage and support the program’s long-term stability. Understanding what Medicare is and how it’s financed can help you better prepare for health care costs in retirement and make more informed financial planning decisions.

Healthcare Tips

• If you need help with Medicare taxes or any other financial issue, consider working with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goal, get started now.
• Life insurance is important to have, especially if you are married or have children. It isn’t always easy to know exactly how much life insurance you should purchase. You can use SmartAsset’s free life insurance calculator to see what you need for your situation.

Photo credit: © iStock/zimmytws, © iStock/MCCAIG, © iStock/DragonImages