The Basics of the 3 Medicare Taxes

There are three tiers of Medicare taxes as of 2018

A medical bill for laboratory services
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The U.S. government imposes a flat rate Medicare tax of 2.9 percent on all wages received by employees, as well as on business or farming income earned by self-employed individuals. But there are a few variations of this tax depending on the sources of your income and other factors. 

The History of the Medicare Program 

The Medicare program and its corresponding tax has been around since President Lyndon B.

Johnson signed the Social Security Amendment into law in 1965. At that time, the flat rate was a mere .70 percent.

The program was designed solely to provide health care benefits to senior citizens and low-income individuals, but then the Social Security Amendment of 1972 expanded the program to cover people with permanent disabilities and end-stage renal disease. Lou Gehrig's disease has also been covered by Medicare since 2001.

The Medicare Hospital Insurance Tax

"Flat rate" means that everyone pays that same 2.9 percent, regardless of how much they earn. But some high-income taxpayers must also pay extra Medicare taxes over and above this 2.9 percent.

Unlike the Social Security tax—the other component of the Federal Insurance Contributions Act or FICA—all your wages and business earnings are subject to at least this 2.9 percent tax. Social Security has a annual wage limit so you only pay the tax on income up to this amount, $128,400 annually as of 2018.

 Medicare taxes apply to all earned income...and then some.

Half the Medicare tax is paid by employees through payroll deductions and half is paid by their employers. In other words, 1.45 percent comes out of your pay and your employer then matches that, paying an additional 1.45 percent on your behalf for a total of 2.9 percent.

Medicare As Part of the Self-Employment Tax 

You'll take something of a double hit on the Medicare tax if you're self-employed. Self-employed persons must pay both halves of the tax because they're both the employee and the employer. Together with also paying both halves of the Social Security tax, this obligation is known as the self-employment tax and you must pay it if you have more than $400 in net business income for the year. 

The Internal Revenue Service does throws self-employed individuals a bit of a bone, however. You're allowed to deduct half your self-employment tax as an adjustment to income "above the line" on the first page of your Form 1040 tax return. Unlike other deductions which you'd claim later on the second page of your return, this one has the benefit of reducing your adjusted gross income (AGI), which is a good thing. Many tax breaks depend on your AGI falling below certain limits. 

The Additional Medicare Tax

The Additional Medicare Tax was added by the Affordable Care Act in November 2013. The ACA increased Medicare by an additional 0.9 percent, but only for individuals whose incomes are over a certain threshold. Those affected pay a total of 3.8 percent in Medicare tax.

 As of 2018, the income thresholds are:

Additional Medicare Tax Thresholds

Filing status

Wages and/or Self-Employed Income in Excess of

Married Filing Jointly

 $250,000

Single or Head of Household or Qualifying Widow(er)

 $200,000

Married Filing Separately

 $125,000

Payroll Withholding for the Additional Medicare Tax

Employers are required to withhold the additional 0.9 percent from employees whose wages are in excess of these threshold amounts, but this can sometimes be tricky.

Employers might not always be aware that an employee is subject to this additional withholding. And if an employee works more than one job, his incomes from both Employer A and Employer B might each fall under the threshold individually but the taxpayer would be liable for the tax when his incomes are added together.

Any shortfall not covered by withholding must be paid by the individual at tax time.

Employers may be subject to penalties and interest for not withholding the Additional Medicare Tax, even if it was due to understandable circumstances.

The Additional Medicare Tax requires completing and filing Form 8959 with your tax return. 

The Net Investment Income Tax 

There once was a time when investment income was not subject to Medicare tax but that changed with the Affordable Care Act, too. A Medicare contribution tax of 3.8 percent now additionally applies to "unearned income"—that which is received from investments, such as interest or dividends, rather than from wages or salaries paid in compensation for labor. This tax is called the Net Investment Income Tax (NIIT).

Tax-exempt interest income is exempt from this tax as well, as are withdrawals from certain retirement plans and life insurance proceeds. But required minimum distributions taken from traditional IRAs, 401(k) plans, or 403(b) plans are included in your modified adjusted gross income (MAGI) and this can be an important distinction. 

The 3.8 percent rate applies to the lesser of your net investment income or your MAGI over a threshold amount. As of 2018, the threshold amounts are:

Net Investment Income Tax Thresholds

Filing status

Modified Adjusted Gross Income

Married Filing Jointly or Qualifying Widow(er) 

 $250,000

Single or Head of Household

 $200,000

Married Filing Separately

 $125,000

For most taxpayers, your modified adjusted gross income or MAGI is the same as your AGI, but if you're unsure, consult with a tax professional. Your MAGI adds certain deductions back to your AGI. 

The irony is that the NIIT actually goes into the government's General Fund... not directly to Medicare. 

Three Types of Medicare Taxes

Many taxpayers only have to deal with that first 2.9 percent flat rate tax. But all told, you could end up paying more than just this small percentage to Medicare if you're a high earner with investment income, although the Additional Medicare tax and the NIIT actually tax two separate forms of income.