Posted by Abundant Wealth Planning LLC

What are Medicare Taxes?

What are Medicare Taxes?

If you've ever taken time to look at your earnings statement from a job, you've probably noticed some tax withholding. As part of its general payroll taxes, the federal government requires employers to collect tax under the Federal Insurance Contributions Act (FICA). The FICA fees include two separate fees. Social Security taxes cover Social Security benefits, and Medicare taxes are used to pay for Medicare hospital insurance that you receive when you are older. However, for this discussion, we'll take a closer look at what Medicare taxes are and how they benefit you. 


Medicare Taxes: the basics

Like Social Security benefits, the Medicare hospital insurance program is largely funded by payroll taxes. If you work "under the table," you will not be paying for these systems. This is why withholding tax, while it takes a portion of your take-home pay, offers something in exchange for missing dollars in your paycheck.

Medicare taxes began in 1966 at a modest rate of 0.7%. Employers and employees were responsible for paying 0.35% each. Employees paid their contributions when their employers deducted them from their wages. Since 1966, the Medicare tax has increased, although it is still lower than the Social Security tax. The social security tax for 2021 is 12.4%, and employees and employers each pay 6.2%.

Today, Medicare's tax rate is 2.9%. Employers and employees share this cost, each paying 1.45%. Unlike Social Security taxes, there is no limit on income subject to Medicare taxes.


Medicare Taxes and Affordable Care Act

The Affordable Care Act (ACA) added tax on Medicare for high-income earners. This surtax is known as the Medicare taxes. Since January 2013, anyone with an income over $200,000 ($250,000 for married filing jointly) must pay an additional Medicare tax of 0.9% on top of the standard 1.45%. The employee pays this total of 0.9%. It is not shared between the employer and the employee.

If your income means you are subject to additional Medicare tax, your Medicare tax rate is 2.35%. However, this Medicare surtax only applies to income over $ 200,000. If you earn $350,000 per year, you will pay Medicare fees of 1.45% for the first $200,000 and 2.35% for the remaining $150,000.

The net investment income tax (NIIT) is another outcome of the ACA reforms. NIIT, a.k.a unearned income medicare contribution surtax, is a 3.8% medicare tax that applies to investment income and regular income above a certain threshold. If your AGI is greater than $200,000 ($ 250,000 married filing jointly), you may be subject to NIIT. Examples of investment income subject to NIIT include dividends, interest, passive income, annuities, royalties, and capital gains.

The 3.8% tax applies to the lower amount of your net investment income or the amount for which the MAGI exceeds $ 200,000 (or $ 250,000 for contributors). This means that NIIT acts as an additional income tax or as an additional capital gains tax. 

According to the Internal Revenue Service, a taxpayer may be subject to additional Medicare and NIIT taxes, but not necessarily the same income types. This is because 0.9% of the additional Medicare tax applies to salaries, benefits, and self-employment income above the $ 200,000 limit but does not apply to net income. 


Bottom Line

The combination of Social Security and Medicare rates, plus income tax withheld from your paycheck, seriously affect your take-home pay. As of 2017, employee participation in Social Security and Medicare taxes was 7.65%. If you earn more than $ 200,000, be sure to factor in additional Medicare taxes. It might seem like a big deal right now, but all of these tax withholding is intended to give you a safety net when you retire. 


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