The Basics of the 3 Medicare Taxes

There are actually 3 Medicate taxes, but most individuals only pay one.

Older woman sitting on an exam table talking to doctor
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The U.S. government imposes a flat rate Medicare tax of 2.9% on all wages received by employees, as well as on business or farming income earned by self-employed individuals. "Flat rate" means that everyone pays that same 2.9% regardless of how much they earn. But there are two other Medicare taxes that may apply to you depending on the sources and amount of your income.

The History of the Medicare Program

The Medicare program and its corresponding tax have been around since President Lyndon Johnson signed the Social Security Act into law in 1965. The flat rate was a mere 0.7% at that time.

The program was initially divided up into Part A for hospital insurance and Part B for medical insurance. It was designed to provide health care benefits to senior citizens and to low-income individuals, but the Social Security Amendment of 1972 expanded the program to cover people with permanent disabilities and end-stage renal disease.

More benefits have been added since then, including coverage of prescription drugs and coverage for those who have Lou Gehrig's disease or are pregnant. 

The Medicare Hospital Insurance Tax

Unlike the Social Security tax—the other component of the Federal Insurance Contributions Act, or FICA, taxes—all of your wages and business earnings are subject to at least the 2.9% Medicare Hospital Insurance program tax. Social Security has an annual wage limit, so you pay the tax only on income above a certain amount: $137,700 annually as of 2020 and $142,800 in 2021.

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

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. You must pay both halves of the tax because you're 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 amounts to 15.3% of your income.

The Internal Revenue Service does throw self-employed individuals a bit of a bone. You're allowed to deduct half your self-employment tax as an adjustment to income on your Form 1040 tax return.

Unlike many other deductions, this one reduces your adjusted gross income (AGI), which is a good thing. Many tax breaks depend on your AGI falling below certain limits.

Calculate the amount of your deduction for half the self-employment tax on Schedule SE, and submit the schedule to the IRS along with your tax return.

The Additional Medicare Tax

Some high-income taxpayers must pay an extra Medicare tax over and above the 2.9% rate.

The Additional Medicare Tax (AMT) was added by the Affordable Care Act (ACA) in November 2013. The ACA increased the Medicare tax by an additional 0.9% for taxpayers whose incomes are over a certain threshold based on their filing status. Those affected pay a total Medicare tax of 3.8%. The income thresholds for various filing statuses in 2020 are in the table.

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

Employers don't have to match the AMT. The employee must pay the entire 0.9%.

Payroll Withholding for the AMT

Employers might not always be aware that an employee is subject to withholding for the AMT. If an employee works more than one job, their incomes from Employer A and Employer B might both fall under the threshold individually, so neither employer would withhold this tax.

The taxpayer would still be liable for the AMT on their combined incomes.

Any shortfall to withholding must be paid by the taxpayer at tax time. Employers can be subject to penalties and interest for not withholding the AMT, even if the oversight was due to understandable circumstances.

If you are subject to the AMT, you must complete and file Form 8959 with your tax return.

The Net Investment Income Tax

There was a time when investment income wasn't subject to the Medicare tax, but that changed with the Affordable Care Act as well.

A Medicare contribution tax of 3.8% 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 or self-employment income. This tax is called the Net Investment Income Tax (NIIT).

Tax-exempt interest income, such as from an investment in municipal bonds, is exempt from the NIIT, as are withdrawals from certain retirement plans and certain 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% rate applies to the lesser of your net investment income or the amount by which your MAGI exceeds a threshold amount. For 2020, the threshold amounts are the same as for the AMT.

Most taxpayers will find that their MAGIs are the same as their AGIs, but consult with a tax professional if you're unsure. Your MAGI adds certain deductions back to your AGI.

Your AGI appears on line 8b of the 2019 Form 1040. This Form 1040 has been revised from the 2018 version and from previous tax years.

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

The Bottom Line

Many taxpayers only have to deal with that first 2.9% flat rate tax, but you could end up paying more than this percentage to Medicare if you're a high earner with investment income.

Article Sources

  1. IRS. "Questions and Answers for the Additional Medicare Tax." Accessed Oct. 22, 2020.

  2. U.S. Department of Health and Human Services. "Milestones 1937-2015," Page 2. Accessed Oct. 22, 2020.

  3. U.S. Department of Health and Human Services. "Who Is Eligible for Medicare?" Accessed Oct. 22, 2020.

  4. Medicare.org. "Does Medicare Cover Pregnancy?" Accessed Oct. 22, 2020.

  5. Social Security Administration. "Contribution And Benefit Base." Accessed Oct. 22, 2020.

  6. IRS. "Topic No. 554 Self-Employment Tax." Accessed Oct. 22, 2020.

  7. IRS. "Questions and Answers on the Net Investment Income Tax." Accessed Oct. 22, 2020.