Medicare Tax: Who Pays Them and Are They Mandatory?

When Americans reach age 65, they become eligible for Medicare, the federal health insurance program. Some younger people with disabilities or end-stage renal disease will also qualify for these benefits. The Federal Insurance Contributions Act (FICA) regulates the United States Medicare and Social Security taxes. Payroll taxes collected from working Americans and their employers generate significant revenue for these social programs. But what is Medicare tax exactly?

Key takeaways:

This article will explore the purpose of Medicare taxes, rates, and the bottom line for your paycheck.

What is Medicare tax?

Most American workers and resident aliens have Medicare taxes deducted from their wages. This money partially funds Medicare services for 65 million Americans. Taxes are collected and kept in a trust fund specifically for Medicare. There are two trust funds, the Hospital Insurance Trust Fund, and the Supplementary Medical Insurance Trust Fund. Payroll taxes go into the Hospital Insurance Trust Fund and are designated specifically for Medicare Part A expenses. Other parts of Medicare are funded differently.

Medicare works because each generation provides revenue for the older generations to have Medicare benefits. You pay mandatory taxes while working, so you can access the same benefits when you leave the workforce. A percentage of your paycheck will go toward these taxes regardless of your hourly rate or salary. Your employer must also contribute taxes on your behalf.

When examining the details of your paycheck, you may notice the Medicare tax lumped under a FICA tax. FICA is a combination of your Medicare and Social Security deductions. Self-employed individuals must also contribute to the Medicare tax.

What is the Medicare tax used for?

Payroll taxes generate about 88% of Medicare Part A's revenue, equaling nearly $285 billion yearly. The remaining income for Part A comes from other taxes and member premiums.

Part A benefits include hospital admissions and inpatient stays, skilled nursing facility admissions, hospice, and home health services. This type of health care is typically expensive. As people age, they often experience increasing health concerns and, as a result, can require complex management for chronic medical conditions.

Why is Medicare tax taken out of your paycheck?

FICA requires American employers to withhold payroll taxes from their employees. You will split the total amount with your employer, who will submit the money on your behalf. These taxes are automatically deducted from your paycheck.

For example, if an individual makes $65,000 in annual earnings, they must contribute 1.45% of their salary to the Medicare tax. This equals $78.50 monthly. Your employer is responsible for contributing the same amount, making your total Medicare tax contribution $157 monthly. For people on a two-week pay period, these sums will likely be broken down to biweekly with year-to-date sums.

What is the Medicare tax rate for 2023?

There was no change in the Medicare Tax rate from 2022 to 2023. It remains at 2.9% per individual. You and your employer will split the 2.9% contributing 1.45% each. Every employed American is subject to the Medicare tax regardless of income.

If you are self-employed, you are responsible for paying the total 2.9% because you are wearing the hats of both the employer and the employee. Self-employed individuals' contributions are typically included under the self-employment tax. However, you may be eligible for FICA deductions, and your tax advisor should be able to provide more information.

Medicare taxes are applied to all types of income, including paid time off, overtime, tips, and bonuses. Pre-tax payroll contributions for health insurance fees or health savings accounts are not taxed, but other payroll contributions can be subject to the Medicare tax.

Medicare surtaxes definition

The Affordable Care Act expanded Medicare benefits for enrollees. Higher-income individuals are subject to additional taxes generating revenue and enabling seniors to access more robust health care.

The current 2023 income thresholds are:

  • $200,000 per individual, regardless of filing status.
  • $125,000 for a married couple filing separately.
  • $250,000 for a married couple filing jointly.

If your income exceeds these thresholds, you are subject to additional taxes. The Medicare surtax, or the Net Investment Income Tax, is a 3.8% tax owed on income derived from interest, dividends, capital gains, royalties, and passive income.

Depending on your situation, it could become quite complicated, and you may be responsible for the Medicare Surtax and the Additional Medicare tax. These two taxes are different and apply to different types of income. If this pertains to you, seeking advice from a financial advisor would be beneficial.

Additional Medicare tax: who pays them?

The Additional Medicare Tax took effect on January 1, 2013. At 0.9%, this tax is applied to high-income earners who exceed the income thresholds. It was enacted along with the Medicare surtax to help fund Medicare expansion. Employers must deduct an extra 0.9% from employees earning above $200,000 annually. So you will pay 1.45% Medicare tax up to $200,000, and then you will pay 2.35 % on earnings above $200,000. Your employer is not required to match the additional 0.9%; it is solely your responsibility.

These additional Medicare taxes provide seniors access to lower prescription drug costs, free preventative care, and routine screening for some cancers, diabetes, and heart disease. Improved access to providers and management of chronic conditions are made possible through these taxes.

When do you stop paying Medicare taxes?

Age alone does not qualify you to stop paying Medicare taxes. If you retire but decide to work part-time or start a business, you will be subject to Medicare taxes.

For most Americans, retirement savings, pension plans, and Social Security are part of their retirement income strategy. Typically, you had already paid taxes on this money when it was earned, so you will not have to pay twice, except for Social Security, which will be subject to income tax. Before retirement, financial advisors can guide you on FICA taxes required from severance pay or deferred compensation.

In rare situations, a person could be exempt from paying Medicare taxes. Examples include religious reasons or someone living in the U.S. as a foreign-employed official.

Can Medicare taxes go up?

Medicare taxes are subject to change. However, rates did not change from 2022 to 2023. Government agencies set tax rates and decide who is responsible for what amounts. If the government decides to increase taxes in the future, it is feasible you could see that reflected in your paycheck.

If your earnings previously exceeded the income thresholds, but now you make less money, your Medicare taxes could go down because you would not be subject to the additional taxes.

If you find yourself unemployed, the earnings from your unemployment checks are not subject to Medicare tax.

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