The Basics of the Medicare Tax

There are three tiers of Medicare taxes as of 2017

A medical bill for laboratory services
© William Andrew / Photographer's Choice RF / Getty Images

The Medicare program and its corresponding tax has been around since President Lyndon B. Johnson signed the Social Security Amendment into law in 1965. It was designed solely to provide health care benefits to senior citizens and low-income individuals at first, but then the Social Security Amendment of 1972 expanded the program to cover people with permanent disabilities and end-stage renal disease as well.

Lou Gehrig's disease has also been covered by Medicare since 2001.

If you don't fall into any of these categories, you might never have given too much thought to that small percentage your employer withholds from each of your paychecks for the Medicare tax. But if you've ever wondered, here's how it works. 

The Medicare Hospital Insurance Tax

The U.S. government imposes a flat-rate Medicare tax of 2.9 percent on all wages received by employees, as well as on business or farming income earned by self-employed individuals. "Flat rate" means that everyone—or almost everyone—pays that same 2.9 percent, regardless of how much they earn. But some high-income taxpayers must also pay an extra Medicare tax over and above this 2.9 percent.

Unlike the Social Security tax—the other component of the Federal Insurance Contributions Act or FICA—all your wages and business earnings are subject to at least a 2.9 percent Medicare tax.

Social Security has a built-in annual wage limit so you only pay the tax on income up to this amount. 

Half the Medicare tax is paid by employees through payroll deductions, and half is paid by their employers. In other words, 1.45 percent comes out of your pay and your employer then matches that, paying in an additional 1.45 percent on your behalf for a total of 2.9 percent.

The Self-Employment Tax 

You'll take something of a double hit on the Medicare tax if you're self-employed. Self-employed persons must pay both halves of the tax because they're both the employee and the employer. Together with also paying both halves of the Social Security tax, this obligation is known as the self-employment tax.

The Internal Revenue Service does throws you a bit of a bone, however. You're allowed to deduct half your self-employment tax as an adjustment to income "above the line" on the first page of your Form 1040 tax return. Unlike other deductions which you'd claim later on the second page of your return, this one has the benefit of reducing your adjusted gross income or AGI, which is a good thing. Many tax breaks depend on your AGI falling below certain limits. 

The Additional Medicare Tax

The Additional Medicare Tax was added by the Affordable Care Act in November 2013. The ACA increased Medicare by an additional 0.9 percent, but only for high-income individuals whose incomes are over a certain threshold. Those affected pay a total of 3.8 percent in Medicare tax. As of 2017, the income thresholds are:

Additional Medicare Tax Thresholds

Filing status

Wages and/or Self-Employed Income in Excess of

Married Filing Jointly

 $250,000

Single or Head of Household or Qualifying Widow(er)

 $200,000

Married Filing Separately

 $125,000

Payroll Withholding for the Additional Medicare Tax

Employers are required to withhold an additional 0.9 percent from employees whose wages are in excess of these threshold amounts, but this can sometimes be tricky. Employers might not always be aware that an employee is subject to this additional withholding. If an employee works more than one job, his incomes from both Employer A and Employer B might each fall under the threshold individually, but the taxpayer would become liable for the tax when his incomes are added together.

Any shortfall not covered by withholding must be paid by the individual at tax time. Employers may be subject to penalties and interest for not withholding the Additional Medicare Tax, even if it was due to understandable circumstances.

The Unearned Income Medicare Contribution Tax

A Medicare contribution tax of 3.8 percent also applies to "unearned income"—that which is received from investments rather than labor, such as interest or dividends.

This tax is called the Net Investment Income Tax. The 3.8 percent rate applies to the lesser of your net investment income or your modified adjusted gross income over a threshold amount. As of 2017, the threshold amounts are:

Net Investment Income Tax Thresholds

Filing status

Modified Adjusted Gross Income

Married Filing Jointly or Qualifying Widow(er) 

 $250,000

Single or Head of Household

 $200,000

Married Filing Separately

 $125,000

For most taxpayers, your modified adjusted gross income or MAGI is the same as your AGI, but if you're unsure, consult with a tax professional. 

All told, you could end up paying more than just a small percentage to Medicare if you're a high earner with investment income.