Will you earn over $200,000 annually in wages and/or net earnings from self-employment? Or do you have employees who earn more than $200,000 in wages annually? If so, here is a tax topic that concerns you.
Beginning in the 2013 tax year, individual taxpayers with earned income in excess of $200,000 if single or head of household, $250,000 if married filing jointly, and $125,000 if married filing separately will have to pay an additional 0.9% in Medicare taxes on earned income above these levels. In contrast to other Medicare taxes, this tax is calculated on a per-return basis, not a per-taxpayer basis.
Now you may be thinking this topic sounds familiar. Back in March 2012 we introduced the 3.8% Medicare tax that will be imposed on unearned income starting in 2013. Both of these taxes are part of the 2010 Health Care Act, which was ruled constitutional by the Supreme Court on Thursday, June 28, 2012.
To illustrate this tax, let’s assume an unmarried taxpayer had wages of $170,000 and Schedule C business income of $75,000 in 2013. The taxpayer would have to pay an additional Medicare tax of $405 as calculated below.
Income subject to additional tax: $170,000 + $75,000 – $200,000 = $45,000
Additional tax: $45,000 X 0.9% = $405
If this taxpayer was married filing jointly instead of single, and this was the only earned income for the household, totaling $245,000, the taxpayer would not be subject to any additional tax because the household would be under the $250,000 threshold. Similarly, two unmarried individuals living together earning $200,000 each would not be subject to the tax while a married couple with each spouse earning $200,000 would be subject.
Now what issues arise for employers with employees earning more than $200,000 in wages? Unlike the current Medicare tax, there is no employer matching requirement for this additional tax. However, there is a withholding requirement, but only for employers paying an individual taxpayer more than $200,000. If a taxpayer earns total wages in excess of $200,000 from multiple employers and no single employer pays wages in excess of $200,000, there is no additional withholding requirement. Or if two spouses filing jointly earn more than $250,000, but neither earns more than $200,000, there is no additional withholding requirement. But if a single employer pays wages to a single taxpayer in excess of $200,000, the additional 0.9% tax must be withheld by the employer.
Let’s consider another example. Two spouses have earned income, one with $225,000 and the other with $185,000. The first spouse has additional employer withholdings of $225 as calculated below. Example:
Income subject to additional withholding: $225,000 – $200,000 = $25,000
Additional required employer withholding: $25,000 X 0.9% = $225
The second spouse has no additional employer withholding because he/she is under the $200,000 threshold. The total tax liability attributable to this additional Medicare tax for earned income of high income individuals totals $1,440 as shown below.
Income subject to additional tax: $225,000 + $185,000 – $250,000 = $160,000
Additional tax: $160,000 X 0.9% = $1,440
Of this $1,440, only $225 was withheld from the employer, leaving $1,215 in additional tax liability at the end of the year.
Reporting will change slightly with this additional tax. An additional line will be added to Form 941, Employer’s Quarterly Federal Tax Return to report this tax. But Form W-2 will not change and all Medicare withholding will be reported in Box 6.
Since this additional tax will create additional liability for individual taxpayers as shown in the example above, those expecting to make more than $200,000 in total but less than $200,000 from each employer may need to increase their withholding on Form WH-4 or make additional estimated tax payments. Employers should not withhold this 0.9% tax unless the taxpayer has received more than $200,000 during the tax year. The employee must plan for this tax with increased income tax withholding or estimated payments.
This tax is not indexed for inflation! This means more taxpayers will likely become subject to this tax as the price level increases. Don’t get stuck with an additional tax liability at the end of 2013. Instead, adjust withholding and estimated payments so you aren’t left with a big bill on April 15, 2014. Contact your CPA and payroll for more information.