Now that we’ve passed the half-year mark, The Tax Warriors at Drucker & Scaccetti are advising our high-income readers and clients to adjust estimated tax and/or withholding allowances to take into account the additional 0.9% Medicare tax that applies for the first time this year. No one wants to be surprised with a large tax bill on April 15, 2014, and that surprise is completely avoidable, if you act now. Our two-part series blog on the Health Care Reform Tax Changes Through 2018 (posted in February if this year) outlined all the tax changes that are a result of the Affordable Care Act. But, for the sake of this post, we will focus only on the 0.9% Medicare tax.
What is this “additional” Medicare tax? Effective in 2013, an additional 0.9% Medicare (hospital insurance, or HI) tax applies to your wages and any other earned income you may have with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately). The tax is in addition to the regular Medicare rate of 1.45% on your wages. The HI tax only applies to the employee portion of the Medicare tax. The employer Medicare tax rate remains at 1.45%, and the employer and employee Social Security tax remain at 6.2%.
Under this new law, the 0.9% additional HI tax is subject to withholding and estimated tax payment requirements. In the case of employees, the additional 0.9% Medicare tax is collected through withholding on FICA wages in excess of $200,000 in a calendar year. In addition, employees may request additional income tax withholding (ITW) on wages on Form W-4 and use this additional ITW to apply against taxes shown on their return, including any additional 0.9% Medicare tax liability. To the extent not withheld, the 0.9% additional Medicare tax should be considered when making estimated tax payments.
Your employer must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. The additional withholding applies in the pay period in which the employer pays wages in excess of $200,000 to an employee, and your employer need not notify you that additional withholding has commenced. Where a payment to you causes your wages to exceed the $200,000 threshold, the additional withholding tax applies only to the portion of the payment that exceeds the threshold. For example, if you earn $180,000 through Nov. 30, 2013, and then receive a bonus of $50,000, your employer withholds the additional Medicare tax on $30,000 (all wages above $200,000).
If you are self-employed, the Medicare tax on self-employment income for any tax year beginning with 2013 is also increased by the additional 0.9% HI tax for self-employment income which exceeds the same thresholds as those for W2 employees (see above). Note: The $250,000, $125,000, and $200,000 thresholds are reduced (but not below zero) by the amount of W2 wages taken into account in determining the additional 0.9% HI tax on W2 wages.
We suggest that you consider having more income tax withheld if you have not had enough Medicare tax withheld. Keep in mind that the additional 0.9% Medicare tax will not be withheld by your employer unless you have received more than $200,000 of wages from that company. Thus, if you began working for a new employer midway through the year, and you expect to exceed the $200,000 threshold only after taking into account wages from all employers during 2013, you could wind up being under withheld. When you add the much higher tax rates and limits on itemized deductions, we predict a lot of sticker shock relating to tax payments due April 2014.
As stated above, the 0.9% additional HI tax applies to both wages and self-employment income. The IRS issued a proposed regulation and Q&A 19 (on which taxpayers may rely) stating that individuals with self-employment income subject to the Self-Employed Contributions Act (SECA) tax and wages subject to FICA tax calculate their liabilities for the additional HI tax in three steps:
(1) Calculate the additional Medicare tax on any wages in excess over the applicable threshold for the filing status ($250,000/$125,000/$200,000), without regard to whether any tax was withheld.
(2) Reduce the applicable threshold for the filing status by the total amount of Medicare wages received (but not below zero).
(3) Calculate the additional Medicare tax on any self-employment income in excess of the reduced threshold.
As we stated in our earlier blog this week, you could be facing a large tax bill next April. If you do, you might need to liquidate investments to pay for the tax increase, which leads to other potential problems and issues such as unplanned taxable capital gains, or untimely asset re-allocations. In short, not planning now could be more costly than the 0.9% tax.
We are encouraging all of our clients to consider having a tax projection prepared as soon as possible to eliminate any surprises going forward. At Drucker & Scaccetti, we are always prepared to help you identify your best course of action regarding this or any other tax-related matter. Learn more about how we help clients prepare for these and other tax changes all year round. We know that taxation is in a state of constant flux and it is extremely difficult for you to keep abreast of all the changes and proposals. That’s why we are just a phone call or mouse click away! Simply contact us via the “Ask A Tax Warrior” button below, or call us at (215) 665-3960. Let our extensive experience in tax matters be your guide in helping you keep as much of your hard-earned wealth as possible.