The Patient Protection and Affordable Care Act (PPACA or “health care reform”) added two new Medicare taxes that become effective January 1, 2013. The first increases the Medicare tax collected by employers on wages of certain high earners. The second imposes a tax on investment income on certain high income individuals. While employees earning more than $200,000 may be subject to both of these taxes, employers only have withholding and reporting obligations for the increased tax on wages. Employers should review their payroll practices and confirm they are ready to comply.
.90% Medicare Tax on Wages
Health care reform amended section 3101(b) of the Code to provide that an employee’s wages in excess of $200,000 (for individuals) are subject to an additional .90% Medicare tax. This raises the employee Medicare tax rate from 1.45% to 2.35% on compensation above $200,000 (for individuals). This additional Medicare tax is imposed only on the employee and not the employer. Therefore, the employer Medicare tax remains at 1.45%. If the employee is married and files jointly or separately, different thresholds apply ($250,000 and $125,000, respectively).
Despite these different thresholds, an employer is required to withhold for the new Medicare tax for all employees whose wages from that employer exceed $200,000, regardless of the employee’s total household wages, marital status, or filing status. If a married employee filing jointly earns more than $200,000 but the married employee’s joint wages are under $250,000, the employee should be able to obtain a refund when the employee files his or her income tax return. Similarly, if an employee’s wages (or household wages) exceed the relevant threshold but no single employer paid the employee more than $200,000, the employee must report and pay the increased Medicare tax.
The IRS has posted a helpful list of frequently asked questions regarding the new .90% Medicare tax. It is available here.
Note that this additional .90% Medicare tax applies to nonqualified deferred compensation and equity compensation. It also applies to self-employed individuals. See section 1401(b)(2) of the Code. There is no obligation to notify employees of the increased Medicare tax.
3.80% Medicare Tax on Modified Adjusted Gross Income/Net Investment Income
Health care reform also added a new section 1411(a)(1) of the Code to provide for a new 3.80% Medicare tax on the lesser of an individual’s (i) modified adjusted gross income (MAGI) for the taxable year, to the extent it is in excess of $200,000 for single filers; $250,000 for married persons filing jointly, and $125,000 for married persons filing separately, or (ii) net investment income for the taxable year. This tax is only triggered if individuals have both MAGI in excess of the relevant thresholds and net investment income.
MAGI generally includes wages and investment income (adjusted gross income potentially increased by amounts excluded from gross income under section 911 over certain deductions and exclusions). Net investment income includes interest, dividends, royalties, rents, and any other such income (such as capital gains and dividends) derived in the ordinary course of a trade or business, and net gain from the disposition of property held for investment. Despite requests, the IRS has not yet provided additional guidance on section 1411.
Unlike the .90% Medicare tax on earned income, employers are not required to withhold or report on the 3.80% Medicare tax on unearned income. Nevertheless, human resource professionals may wish to alert higher compensated employees at their organizations to both of these two new Medicare taxes.
From W-2 Reporting and Payroll Taxes
In addition to these taxes, as discussed in our prior client alert (available here), employers are required to report the value of employer-provided health care on Form W-2. Eventually, this information may be used to determine whether the “Cadillac plan” tax applies. See also IRS Notice 2012-9 (available here). Moreover, effective January 1, 2013, Social Security taxes will return to 6.20% instead of the current reduced 4.20%. With all of these changes, employers should confirm their payroll systems and payroll providers are ready.