Editor: Albert B. Ellentuck, Esq.
Under the 2010 Patient Protection and Affordable Care Act, P.L. 111-148, beginning in 2013, individuals must pay an additional 0.9% Medicare tax on earned income above certain thresholds. This tax applies to both wage income and self-employment (SE) income. The IRS has issued proposed regulations regarding the additional 0.9% Medicare tax that can be relied on until final regulations are published. It has also issued a set of frequently asked questions (FAQs) that are not authoritative guidance but do provide insight into how the IRS plans to administer the new tax.
Imposition of Tax on Wages and Other Compensation
Beginning in 2013, the employee portion of the Medicare tax is increased from 1.45% to 2.35% on wages received in a calendar year in excess of $200,000 ($250,000 for married couples filing jointly; $125,000 for married filing separately) (Sec. 3101(b)(2)). Employers must withhold and remit the increased employee portion of the Medicare tax for each employee whose wages for Medicare tax purposes from the employer are over $200,000 (Sec. 3102(f)(1)).
All wages subject to the 1.45% Medicare tax, including taxable noncash fringe benefits and nonqualified deferred compensation, are subject to the 0.9% additional Medicare withholding tax and are taken into account in determining the $200,000 threshold for withholding purposes (IRS FAQs No. 32 and No. 36).
The employer must begin withholding the additional 0.9% Medicare tax in the pay period in which the employee’s calendar-year wages subject to Medicare tax exceed $200,000, regardless of the employee’s filing status or other income. Withholding is required even if the employee will not be subject to the tax because his or her wages, when combined with a spouse’s wages, will not exceed the $250,000 married-filing-jointly threshold (Prop. Regs. Secs. 31.3102-4(a) and 31.3202-1(g); IRS FAQs No. 8, No. 15, and No. 24).
Example 1: J, a single individual, works for T Inc. T pays J $250,000 in 2013, and he has no other earned income. Because J’s total wages in 2013 are more than $200,000, he must pay an additional 0.9% Medicare tax on the wages over $200,000 (i.e., on $50,000). J’s total additional Medicare tax is $450 ($50,000 × 0.009). T must withhold an additional 0.9% Medicare tax from J’s salary beginning with the paycheck in which his annual Medicare wages exceed $200,000. The additional taxes are remitted with T’s other employment taxes.
Example 2: M is married to S and works for E Inc. M is paid $230,000, and he has no other earned income during 2013. S is not employed. Because M’s 2013 salary exceeds $200,000, E must withhold and remit an additional 0.9% Medicare tax on the excess (i.e., on $30,000). The total additional Medicare tax withheld is $270 ($30,000 × 0.009). But because M and S file a joint income tax return and their total combined wages are less than the $250,000 threshold for married filing jointly, the additional 0.9% Medicare tax does not apply to them. The $270 will be credited against the total tax liability shown on their income tax return. Therefore, assuming they do not owe any other federal income taxes, interest, or penalties to which the withholding could be applied, they will receive a $270 refund of the additional 0.9% Medicare tax withholding.
Generally, an employer takes into account only the wages it pays an individual during the calendar year when determining whether the $200,000 threshold has been met. For example, if an individual begins working for the employer in November, the employer does not consider any wages earned by that individual from another business prior to November to determine whether the $200,000 threshold has been met and the additional Medicare tax withholding applies. It only considers the amounts it pays in November and December to determine if or when the $200,000 threshold is met.
The employee is responsible for paying any of the additional 0.9% Medicare tax that is not withheld by an employer (Sec. 3102(f)(2); Prop. Regs. Sec. 31.3102-4(b)). The additional tax will be calculated and reported on the individual’s federal income tax return.
Because the additional 0.9% Medicare tax applies at different income levels, depending on the employee’s marital status and filing status, some employees may have the additional 0.9% Medicare tax withheld when it will not apply to them (e.g., the employee earns over $200,000, is married and filing jointly, and total compensation for both spouses is $250,000 or less). In such a situation, the additional tax will be treated as additional income tax withholding that is credited against the total tax liability shown on the individual’s income tax return.
Alternatively, an employee may not earn over $200,000, but be subject to the additional 0.9% Medicare tax (e.g., a married person filing a separate return is subject to the tax on earnings over $125,000). Or an individual’s wages may not be over $200,000, but when combined with a spouse’s wages, total wages exceed the $250,000 threshold. When a portion of an individual’s wages will be subject to the additional tax, but earnings from a particular employer do not exceed the $200,000 threshold for withholding of the tax by the employer, the employee is responsible for calculating and paying the additional 0.9% Medicare tax. The employee cannot request that the additional 0.9% Medicare tax be withheld from wages that are under the $200,000 threshold. However, he or she can make quarterly estimated tax payments or submit a new Form W-4, Employee’s Withholding Allowance Certificate, requesting additional income tax withholding (IRS FAQ No. 10).
Example 3: J and R are married. J’s 2013 salary is $180,000, and R’s 2013 wages are $150,000. They have no other wage or investment income. Their total combined wage income in 2013 is $330,000 ($180,000 + $150,000). Because this amount is over $250,000, they owe the additional 0.9% Medicare tax on $80,000 ($330,000 - $250,000). The additional tax due is $720 ($80,000 × 0.009). Neither J’s nor R’s employer is liable for withholding and remitting the additional tax because neither met the $200,000 wage threshold.
Either J or R (or both) can submit a new Form W-4 to his or her employer that will result in additional income tax withholding to ensure the $720 is properly paid during the year. Alternatively, they could make quarterly estimated tax payments. If the amount is not paid until their federal income tax return is filed, they may be responsible for the estimated tax penalty on any underpayment amount (whether the underpayment is actually income taxes or the additional Medicare taxes).
Planning tip: An individual who changes jobs during the year (or begins work during the year) should determine whether the additional 0.9% Medicare tax will apply based on total expected earnings for the calendar year from all employers (including wages earned by a spouse, if applicable). Additionally, married individuals with total Medicare wages over $250,000 should be sure their combined federal income tax withholding for the year is sufficient to cover the additional 0.9% Medicare tax that will be due, especially if neither employer is obligated to withhold the additional amount. If the additional 0.9% Medicare tax applies, but withholding for the tax does not apply (because no employer paid wages over $200,000 during the calendar year), a revised Form W-4 requesting additional income tax withholding should be submitted to an employer, or estimated tax payments should be made so a large tax liability is not due when the individual’s personal tax return is filed.
Imposition of Tax on Self-Employment Income
The additional 0.9% Medicare tax applies to net SE income over $200,000 for unmarried individuals, $125,000 for married separate filers, and combined net SE income above $250,000 for joint filers. These thresholds are not scheduled to be adjusted for inflation. However, the income thresholds for SE tax purposes are reduced by any wages earned by the individual that were taken into account in determining the additional 0.9% Medicare tax (Sec. 1401(b)(2)). Stated another way, the thresholds apply first to total wages, with the remainder used by the SE income (Prop. Regs. Sec. 1.1401-1(d)(2)).
For self-employed individuals, the effect of the additional 0.9% Medicare tax is a higher SE tax. Starting in 2013, the maximum rate for the Medicare tax component of the SE tax is 3.8% (2.9% + 0.9%). Self-employed individuals should include this additional tax when calculating estimated tax payments. Any tax not paid during the year (either through federal income tax withholding from an employer or estimated tax payments) is subject to an underpayment penalty.
The additional 0.9% Medicare tax is not deductible for income tax purposes as part of the Sec. 164(f) SE tax deduction (Sec. 164(f)(1)). Also, it is not taken into account in calculating the deduction under Sec. 1402(a)(12) used for determining the amount of income subject to SE taxes.
This case study has been adapted from PPC’s Guide to Tax Planning for High Income Individuals, 14th Edition, by Anthony J. DeChellis, Patrick L. Young, James D. Van Grevenhof, Timothy Fontenot, and Delia D. Groat, published by Thomson Tax & Accounting, Fort Worth, Texas, 2013 (800-323-8724; ppc.thomson.com).
Albert Ellentuck is of counsel with King & Nordlinger LLP in Arlington, Va.