The Basics of the 3 Medicare Taxes

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

A medical bill for laboratory services
•••

William Andrew / Photographer's Choice RF / Getty Images

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 a few variations of this tax depending on your sources of income and other factors.

The History of the Medicare Program

The Medicare program and its corresponding tax have been around since President Lyndon Johnson signed the Social Security Amendment into law in 1965. The flat rate was a mere .70% 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 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 also been added, including prescription drug coverage. Pregnant women are now covered, and Lou Gehrig's disease has been covered by Medicare since 2001.

The Medicare Hospital Insurance Tax

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 the 2.9% Medicare tax. Social Security has an annual wage limit, so you only pay the tax on income up to a certain amount, $132,900 annually as of 2019. 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% 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 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.

The Internal Revenue Service does throw self-employed individuals a bit of a bone, however. You're allowed to deduct half your self-employment tax as an adjustment to income on your Form 1040 tax return. Unlike other deductions which you'd claim later on your return, this one reduces 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

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

The Additional Medicare Tax was added by the Affordable Care Act in November 2013. The ACA increased Medicare by an additional 0.9% for individuals whose incomes are over a certain threshold. Those affected pay a total of 3.8% in Medicare tax. As of 2019, 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

Employers don't have to match the Additional Medicare Tax. The employee must kick in the entire 0.9%.

Payroll Withholding for the Additional Medicare Tax

Employers might not always be aware that an employee is subject to this additional withholding. If an employee works more than one job, his incomes from both Employer A and Employer B might each fall under the threshold individually so no one is withholding this tax, but the taxpayer would still be liable for it when his incomes are combined.

Any shortfall not covered by withholding must be paid by the individual at tax time. Employers can be subject to penalties and interest for not withholding the Additional Medicare Tax, even if the oversight 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 was a time when investment income wasn't subject to the Medicare tax, but that changed with the Affordable Care Act, too. 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. 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 (RMDs) 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 your MAGI over a threshold amount. As of 2019, 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

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

Your AGI appears on line 7 of the new Form 1040 that went into effect with the 2018 tax year.

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.