What Is Medicare Tax and How Does It Work?

Medicare tax is a federal employment tax that helps fund the Medicare program, which provides health insurance primarily for individuals aged 65 or older and certain younger people with disabilities. This tax is a component of the Federal Insurance Contributions Act (FICA) tax, established to ensure a dedicated funding source for these social insurance programs. The tax helps support the hospital insurance portion of Medicare, known as Part A.

Fundamentals of Medicare Tax

Medicare tax is a payroll tax levied on wages and earnings. It forms part of the broader FICA tax, which also includes Social Security tax. Unlike the Social Security tax, which has a wage base limit, the Medicare tax applies to all covered earnings without any income cap. This means every dollar of wages, salaries, and net earnings from self-employment is subject to Medicare tax. Covered earnings generally encompass most forms of compensation received for services performed, including salary, wages, bonuses, tips, and commissions.

Who Pays Medicare Tax

Employees have a portion of Medicare tax withheld directly from their paychecks. Employers also contribute a matching portion. This dual contribution ensures both the worker and the employer contribute to the Medicare system.

Self-employed individuals, such as independent contractors or sole proprietors, bear the full responsibility for both the employee and employer portions of the tax. This combined responsibility is referred to as self-employment tax. They pay this tax on their net earnings from self-employment, meaning their business income after deducting allowable expenses. Unlike employees who split the tax burden with employers, self-employed individuals are responsible for the entire amount.

Calculating Medicare Tax Liability

The standard Medicare tax rate is 2.9% of covered earnings. This rate is split equally between the employee and the employer, with each paying 1.45%. For self-employed individuals, the entire 2.9% rate applies to their net earnings from self-employment.

An additional Medicare tax of 0.9% applies to individuals with income exceeding certain thresholds. For single filers and those filing as head of household, this threshold is $200,000. For married couples filing jointly, the threshold is $250,000, and for married individuals filing separately, it is $125,000. This additional tax applies only to the employee or self-employed individual, not the employer. For example, a single filer earning $250,000 would pay the standard 1.45% on the first $200,000 and 2.35% (1.45% plus 0.9%) on the remaining $50,000.

How Medicare Tax is Collected

For employees, Medicare tax is collected through payroll withholding. Employers are responsible for deducting the employee’s share of Medicare tax from each paycheck and remitting it, along with their matching employer share, to the Internal Revenue Service (IRS). This withheld amount is reported on the employee’s Wage and Tax Statement, Form W-2, at the end of the year.

Self-employed individuals and those with significant income not subject to withholding, such as from investments, are required to pay Medicare tax through quarterly estimated tax payments. These payments cover both their income tax and self-employment tax obligations, including the Medicare tax component. The Additional Medicare Tax is also subject to withholding by employers once an employee’s wages exceed $200,000 in a calendar year, regardless of the employee’s filing status. Individuals should adjust their estimated tax payments if other income sources or insufficient withholding lead to an Additional Medicare Tax liability. All these tax payments are reported on annual tax forms, such as Form 1040 and Schedule SE for self-employed individuals.