It was designed in 2010 to help fund the provisions of the Affordable Care Act, and now it’s finally taken clearer shape: On November 30 the IRS issued proposed regulations regarding the additional 0.9 percent Medicare tax, which takes effect January 1, 2013. How will the tax affect individuals, employers, and payroll service providers? Let’s take a closer look.
Currently, under the Federal Insurance Contributions Act (FICA), wages are subject to a 2.9 percent Medicare tax—1.45 percent paid by employers and 1.45 percent withheld from employees’ wages. Beginning in 2013, employees will be subject to the 0.9 percent additional Medicare tax on FICA wages and self-employment income to the extent they exceed the following threshold amounts: $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for individuals, heads of household, and other filers.
Unlike regular Medicare taxes, the additional Medicare tax doesn’t include a corresponding employer portion. But employers are obligated to withhold the additional tax to the extent that an employee’s wages exceed $200,000 in a calendar year.
Calculating the Tax
Individuals are required to report and pay additional Medicare taxes on their income tax returns. The tax is calculated by multiplying the excess of wages (or self-employment income) over the applicable threshold by 0.9 percent. For example, a husband and wife who each earn $150,000 in FICA wages would be liable for additional Medicare taxes on $50,000 (the excess of their combined $300,000 in wages over the $250,000 threshold for joint filers).
The proposed regulations make it clear that an employer is required to withhold additional Medicare tax on wages in excess of $200,000 in a calendar year, without regard to the employee’s filing status or his or her income from other sources. This means that in some cases employers will be required to withhold the tax from wages paid to employees who aren’t liable for the tax—because, for example, their wages, together with those of their spouse, don’t exceed the $250,000 threshold for joint filers.
According to the IRS, in this situation an employee cannot ask the employer to stop withholding the tax. Rather, the employee should claim a credit for the withheld taxes on his or her income tax return for the year.
It’s also possible that no taxes will be withheld from employees who are liable for the tax. Suppose, for example, that a husband and wife file jointly and each has $175,000 in FICA wages. Neither of their employers would be required to withhold additional Medicare taxes, yet they’d be liable for the tax to the extent their wages exceed the $250,000 threshold. In this case the tax would be:
0.9 percent × ($350,000 − $250,000) = $900
Similarly, no tax would be withheld if an individual has two jobs and neither job pays wages in excess of the threshold.
Employees who anticipate additional Medicare tax liability should use Form W-4 to request additional income tax withholding sufficient to cover their liability for the additional Medicare tax. To the extent this additional liability isn’t covered by employer withholding, employees should use estimated tax payments to make up the shortfall to avoid interest and underpayment penalties.
Employers are required to begin withholding additional Medicare tax in the pay period in which it pays wages in excess of $200,000 to an employee. An employer that fails to meet its withholding, deposit, reporting, and payment responsibilities is liable for additional Medicare tax plus all applicable penalties. If the employee pays the tax, the employer is relieved of liability for the tax but may still be subject to penalties.
Adjustments and Refund Claims
The proposed regulations allow employers to make interest-free adjustments in the event of under- or overpayments of additional Medicare tax. Generally, this is done by filing the appropriate corrected return (for example, Form 941-X) and then either reimbursing overpaid amounts to the employee or collecting underpaid amounts from the employee’s wages before the end of the year.
Underpayments may be adjusted only if the error occurs during the same year the underlying wages were paid (with certain exceptions, including underpayments attributable to administrative errors or IRS examinations). The employer is liable for the correct amount of tax, even if it’s unable to deduct underpaid taxes from the employee’s wages.
Overpayments may be adjusted if the employer ascertains the error in the year the wages were paid and reimburses the employee for overcollected amounts by the end of the year. If the employer is unable to reimburse the employee by year-end, it should not make an adjustment. Instead it should report the amount withheld on the employee’s W-2 so the employee can obtain credit for the tax (and, if appropriate, a refund) on his or her individual income tax return.
The proposed regulations allow an employer to claim a refund of overpaid additional Medicare tax, provided it didn’t deduct or withhold the overpaid amounts from the employee’s wages.
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To be ready when the new tax takes effect, employers should be sure their payroll procedures and systems are equipped to handle the new withholding requirements. High-income taxpayers should evaluate their liability for the tax and adjust their withholdings or estimated tax payments accordingly.
For additional information about the new tax, what it could mean for your business, and advice on how to prepare for it, contact your Moss Adams tax professional.
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