Medicare tax is a federal payroll tax that contributes to Medicare funding. All U.S.-based workers are required to pay Medicare tax on their wages. In accordance with the Federal Insurance Contributions Act (FICA), the tax is grouped together. When reviewing your paycheck, the Medicare tax and Social Security tax may appear as a single deduction for FICA.
The Medicare tax was established in 1966 to solve a health care problem: after retirement, the income of many seniors declines while their health care needs increase. Before Medicare, however, the cost of insurance became unmanageable, and some retirees’ policies were terminated due to their age. There are numerous components to the Medicare program, but at the time, the working population was required to pay a new Medicare tax to support Medicare hospital insurance. Below we’ll take a look at how Medicare taxes work.
How Medicare Tax Works
Medicare tax is a two-part tax: a portion is automatically deducted from your paycheck, and the other portion is paid by your employer. The tax is based on “Medicare taxable wages,” which is calculated by subtracting pretax health care deductions such as medical insurance, dental, vision, and health savings accounts from your gross pay.
Your employer is required to collect tax, and it electronically deposits both the employee and employer versions to the IRS on a regular basis. Self-employed individuals pay a Medicare tax as part of their self-employment tax. Instead of being deducted from a paycheck, the money is paid quarterly through estimated tax payments.
Medicare Tax Rate
When the Medicare tax was first introduced in 1966, the tax rate was 0.7% of an employee’s wages, with the employer and employee each paying 0.35%. The rate has since gone up considerably. In 2023, the Medicare tax rate is 2.9% which is still shared equally between the employer and employee. W-2 employees pay 1.45% towards the Medicare tax and their employer covers the remaining 1.45%. Self-employed individuals must pay the full 2.9% in full because they are both the employee and the employer.
To fund the Medicare expansion, the Affordable Care Act imposed 2 Medicare surtaxes in 2013: The additional Medicare tax and the net investment income tax. Both surtaxes apply to high-income earners and are specific to distinct income types. It is possible to be subject to both of these surtaxes.
Additional Medicare Tax
The additional Medicare tax only applies to income above $200,000 ($250,000 for joint tax filing and $125,000 for married taxpayers filing separately). The additional Medicare tax rate is 0.9%. For example, if you earn $225,000 per year, the first $200,000 is subject to the standard 1.45% Medicare tax, while the remaining $25,000 is subject to the 0.9% additional Medicare tax. Similar to the initial Medicare tax, the surtax is withheld from an employee’s paycheck or paid through self-employment taxes.
Net Investment Income Tax
The net investment income tax, also known as the “unearned income Medicare contribution surtax”, imposes an additional 3.8% tax on net investment income as of 2023. As with the additional Medicare tax, no employer contribution is required. Net investment income can include taxable interest, dividends, nonqualified annuities, capital gains, and rental income. It excludes income that is already excluded for income tax purposes, such as interest on tax-exempt municipal bonds.
Net investment income tax is applied to your net investment income or the excess modified adjusted gross income (MAGI) over certain thresholds, whichever is less. Suppose, for example, that a married couple joint filing earned $225,000 in pay. The couple received an additional $50,000 in investment income during the same year, bringing their MAGI to $275,000. The tax threshold on net investment income for married couples filing together is $250,000. The couple would pay the 3.8% tax on the lesser income which would be the excess MAGI at $25,000 and not the total investment income which was $50,000. In this situation the couple would owe $950 in net investment income tax (3.8% x $25,000).
What Is The Medicare Tax Used For?
The Medicare tax funds Medicare Part A, which provides health insurance for those 65 and older, those with disabilities, and those with certain medical conditions. Medicare Part A, also known as hospital insurance, pays for hospital stays, skilled nursing care, hospice care, and certain home health services. The tax collected for Medicare accounts for 88% of Medicare Part A’s total revenue.
What Is The Additional Medicare Tax Used For?
The additional Medicare tax paid by high-income earners is used to offset the costs of the Affordable Care Act, according to the IRS. The funds are used to pay for provisions of the ACA, including the provision of tax credits for health insurance, to make health insurance more affordable for over 9 million individuals.
What Is The Medicare Trust Fund?
Medicare trust funds are what provides the money to fund Medicare beneficiaries. It is primarily made up of 2 funds:
- Hospital Insurance Trust Fund (HI) – This fund finances Medicare Part A, which covers hospital stays, skilled nursing facilities, and hospice care for eligible beneficiaries. The fund’s primary sources of revenue are payroll taxes and Social Security benefits taxation. In addition, this fund and the Railroad Retirement account contribute to the annual revenue.
- Supplemental Medical Insurance Trust Fund (SMI) – This fund finances Medicare Part B, which covers physician services, essential medical supplies, and a portion of the more recent Medicare Part D prescription drug program. This fund’s primary revenue source is beneficiary premiums, and it does not require a sizable amount of reserves.
Can I Opt Out Of Medicare Tax?
A religious exemption is possibly the most common way to avoid paying FICA tax. Members of recognized religious organizations that oppose accepting Social Security benefits are permitted to opt out. Although the rules and reporting requirements are very strict. The IRS outlines the rules, including the need to submit forms 4631 and 8274. So, don’t get any ideas about starting a religion just to avoid these taxes. The religious organization must have existed since 1950 and be able to demonstrate that its members have a sufficient standard of living during that time.
There are additional, even less likely ways to afford paying FICA. In some cases, these include nonresident aliens and income from student employment. The student exemption only applies to the student’s school-related employment. They must also be enrolled in the school where they work for their income to be exempt from taxation. The IRS has clarified the student-employee exemptions, restricting its eligibility. There may be a few other rare exemptions, such as for the children of family-owned businesses. Some participants in state and local pension plans may also be exempt from Social Security tax. Some of these employees are not covered by Social Security, and therefore do not pay FICA taxes.
What Wages Are Subject To Medicare Tax?
Medicare tax applies to all taxable employment income. This includes a variety of income sources, including salary, overtime, paid time off, tips, and bonuses. There is no limit on the amount that is taxed; all taxable income is subject to Medicare tax. Medicare wages may exclude certain pretax deductions, while others are included. Pre-tax medical insurance premiums and contributions to a health savings account are not taxed. However, Medicare tax is assessed on retirement account contributions and life insurance premiums, despite the fact that these funds are exempt from federal income tax.
If you never paid Medicare taxes it doesn’t mean you can’t sign up for Medicare when the time comes. It just means that you will have to pay a premium for Medicare Part A, which is normally free thanks to those Medicare taxes. As of 2023, if you don’t qualify for free Part A, the premiums can cost up to $506 a month. This also applies if you were unemployed for at least 10 years (40 quarters). Typically, you won’t be eligible for premium-free Part A insurance in this circumstance. However, if your spouse is eligible for free Part A and you meet citizenship and residency requirements you can also be eligible for free Part A.
What is a Medicare deduction on my paycheck?
If Medicare is deducted from your paycheck, it indicates that your employer is fulfilling its payroll obligations. This Medicare Hospital Insurance tax is a mandatory payroll deduction that funds health care for seniors and individuals with disabilities.
What if my employer didn’t withhold FICA taxes?
Employers who violate tax laws by failing to withhold FICA taxes for Social Security and Medicare could face criminal and civil penalties. Check with your employer to ensure there was no error or that you did not claim exemption on your W-4 form if you discover that no taxes have been withheld. You may be required to pay a tax penalty at the end of the year if you underpaid.
What is a Medicare benefit tax statement?
This statement confirms that you are enrolled in Medicare Part A and have health insurance that meets the requirements of the Affordable Care Act. This form, also known as a 1095-B, can be used if the IRS requests verification of your health insurance coverage.
Working With EZ
Due to the Social Security and Medicare taxes, your net pay may not be as high as you would like. Nonetheless, these taxes provide you with retirement insurance. You can enroll in Medicare even if you have not paid enough Medicare taxes over your lifetime. Just be prepared to pay the Part A premiums that other seniors will receive for free. Medicare is beneficial, but it can be confusing. However, you will still need to make decisions regarding your healthcare after enrollment. Speak with an EZ representative who can explain everything and tell you how to sign up.
EZ can help you enroll in Medicare, purchase a Medicare Supplement Plan, or simply weigh your options. Our agents work with the nation’s top insurance providers. They can provide you with a complimentary comparison of all local plans. We will discuss your medical and financial needs and assist you in locating a plan that meets all of your specifications. Simply call one of our licensed agents at 877-670-3602 to get started.