Medicare Taxes under Affordable Care Act

Tax Professionals' Resource
February 24, 2013 — 1,145 views  
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There were two significant Medicare tax changes proposed in the federal health care law of 2010, which have come into effect since January 1, 2013. One of these changes levies a 3.8% Medicare surtax on people of certain income slabs. The other levies an extra 0.9 % of Medicare tax on the same income slabs. If you are interested in investing, then remember the simple rule of investing tax-saving assets in taxable accounts and making tax-inefficient investments in non-taxable accounts. Also, municipal bond interests are devoid of investment surtax. Here is a general idea about what these changes and new taxes may mean to the taxpayers.

Medicare Surtax

The Medicare Surtax is payable at 3.8 % for people coming under 3 income slabs as follows: people who are single and have a total income greater than $200,000; people who are married, are filing jointly, and together have a total income greater than $250,000; married people who are filing separately, and having an income greater than $125,000 each. The total income will be calculated as the modified adjusted gross income (MAGI) or the net investment income, whichever is less. The MAGI is composed of the exclusion for foreign-earned income added to the adjusted gross income.

How Does It Work?

The scenario of every taxpayer is different. However, the surtax will in general work as explained here. If a person has $100,000 in modified adjusted gross income, in which $75,000 is his salary and $25,000 is his net investment, then that person is not required to pay the surtax since his MAGI is not greater than $200,000. A person having a total MAGI of $225,000 with a salary of $100,000 and net investment income of $125,000 is liable to pay 3.8 % of $25,000, since that is the amount which is in excess of the $200,000 threshold. Again, if there is a married couple who have a total MAGI of $400,000, composed of $325,000 in adjusted gross income and $75,000 in investment income, then this couple’s MAGI exceeds the $250,000 threshold by $150,000. But, according to the rule discussed above, they will be charged 3.8 % of $75,000 – their net investment income – since it is the lesser amount of the two – the total MAGI and the net investment income.

Increase in Tax

Medicare taxes were charged at 1.45 % of the income for all employees previously. From January 1, 2013, this rate has been changed. It will now be charged according to separate income slabs. If the income exceeds the threshold for a certain slab, then the employee will be charged 1.45 % of the total income up to that threshold, and an additional 2.35 % for the income in excess of the threshold. For example, if an employee earns $250,000, then he will be charged at 1.45 % up to $200,000 and at 2.35 % for the remaining $50,000. So the total Medicare tax that he will have to pay will be 1.45x200,000 + 2.35x50,000 = 2900 + 1175, which is a total of $4075. So, now the Medicare taxes that employees have to pay have been increased by 0.9 % above the thresholds for their income slabs.

Tax Professionals' Resource