Medicare

What Is Medicare Tax? Definitions, Rates and Calculations

What Is Medicare Tax? Definitions, Rates and Calculations

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Medicare tax is a deduction from each paycheck to pay for Medicare Part A, which provides hospital insurance to seniors and people with disabilities. The total tax amount is split between employers and employees, each paying 1.45%. High-income earners pay a slightly higher percentage, and those who are self-employed pay the tax with their quarterly filings.

What does Medicare tax mean?

Medicare tax is a federal payroll tax that pays for a portion of Medicare. Because of the $284 billion paid in Medicare taxes each year, about 63 million seniors and people with disabilities have access to hospital care, skilled nursing and hospice.

Generally, all U.S.-based workers must pay the tax on their wages. The tax is grouped together under the Federal Insurance Contributions Act (FICA), and when looking at your paycheck, you may see the Medicare tax combined with the Social Security tax as a single deduction for FICA.

The Medicare tax was established in 1966 to solve a health care problem. For many seniors, there was an affordability issue because incomes usually decline after retirement, and during aging, health care costs can increase. There was also an access issue because insurers were canceling some policies of the elderly because their age made them a high risk to insure.

The Medicare program has many components, but a key change at the time was the working population would pay a new Medicare tax to support Medicare hospital insurance.

How does it work?

Medicare tax is a two-part tax where you pay a portion as a deduction from your paycheck, and part is paid by your employer. The deduction happens automatically as a part of the payroll process.

The tax is calculated off of what's called "Medicare taxable wages," which uses your gross pay and subtracts pretax health care deductions such as medical insurance, dental, vision or health savings.

Your employer is required to collect the tax as a part of the IRS Employer's Tax Guide (Publication 15), and it sends both the employee and employer version to the IRS through regular electronic deposits.

For example, an individual with an annual salary of $50,000 would have a 1.45% Medicare tax deducted from their paycheck. That's about $60 each month. The employer would pay an additional $60 each month on their behalf, totaling $120 contributed to Medicare.

Those who are self-employed pay a Medicare tax as a part of the self-employment tax. Rather than being deducted from a paycheck, it's paid through quarterly estimated tax payments.

The Medicare tax rate has remained unchanged since 1986. However, the Additional Medicare Tax for high-income earners was implemented in 2013 as a part of the Affordable Care Act.

What is the Medicare tax used for?

The Medicare tax pays for Medicare Part A, providing health insurance for those age 65 and older as well as people with disabilities or those who have certain medical issues. Medicare Part A, also known as hospital insurance, covers health care costs such as inpatient hospital stays, skilled nursing care, hospice and some home health services.

The tax collected for Medicare accounts for 88% of the total revenue for Medicare Part A.

Medicare Tax revenue

Total revenue for Medicare Part A

  • Medicare payroll tax: 88% ($284 billion)
  • Other funding from taxes, premiums, transfers and interest: 12% ($39 billion)

All revenue for Medicare Part A goes into the Hospital Insurance (HI) trust fund, which is slowly being depleted because the expenses for associated health services have generally been higher than the fund's annual revenue. In 2021, the Congressional Budget Office (CBO) projected the HI trust fund will be fully depleted by 2026.

What is the Additional Medicare Tax used for?

Even though it has Medicare in the name, the Additional Medicare Tax paid by high-income earners is used to offset the costs of the Affordable Care Act (ACA), according to the IRS.

In 2021, a total of about $12.3 billion is expected to be paid on employee earnings in excess of $200,000. These funds are used for the provisions of the ACA, including providing health insurance tax credits to make health insurance more affordable for more than 9 million people.

What's the current Medicare tax rate?

Medicare tax rate

In 2021, the Medicare tax rate is 1.45%. This is the amount you'll see come out of your paycheck, and it's matched with an additional 1.45% contribution from your employer for a total of 2.9% contributed on your behalf.

2021 Medicare tax rate
You pay1.45%
Your employer pays1.45%

If you're a high-income earner, you'll pay an Additional Medicare Tax withholding of 0.9% on any wages that exceed the annual earnings threshold. In 2021, this threshold is $200,000 for individuals and $250,000 for those who file jointly.

2021 Additional Medicare Tax for high-income earners
Base rate you pay1.45%
Additional amount you pay on income above the annual threshold0.9%
Your employer pays1.45%

For those who are self-employed, the full 2.9% must be paid by the individual, rather than splitting the tax with an employer. This tax toward Medicare is included in the self-employment tax that is paid quarterly through estimated tax payments.

The self-employment tax amount is based on net earnings calculated using IRS form Schedule SE. Even though the tax rate is higher for the self-employed, it's being paid on a smaller portion of income because the taxable income is 92.38% of net profit.

For high-income self-employed earners, the Additional Medicare Tax of 0.9% also applies for any income above the annual threshold.

2021 Medicare tax for self-employed
Rate you pay on 92% of net earnings2.9%
Additional amount you pay on income above the annual threshold0.9%

What wages are subject to the Medicare tax?

All taxable employment earnings are subject to the Medicare tax. This includes multiple types of income such as salary, overtime, paid time off, tips and bonuses. There is no cap on the amount that's taxed, and even though you only pay Social Security tax on the first $142,800 of income, you may pay Medicare tax on all taxable income.

Some pretax deductions may be excluded from Medicare wages, but others are included. Pretax payments for medical insurance or contributions toward a health savings account are not included in the amount that's taxed. However, Medicare tax is charged on the funds you contribute to a retirement account and premiums paid for life insurance, even though these funds are excluded from your federal income taxes.

Are Medicare taxes also charged on investment income?

The Net Investment Income Tax (NIIT) was established in part 2 of the Affordable Care Act in a section titled the Unearned Income Medicare Contribution. For those who received investment income, this act charges a 3.8% tax on whichever is less — net investment income (capital gains, dividends, interest) or modified adjusted gross income in excess of the annual threshold ($200,000 for individual filers or $250,000 for joint filers).

Even though the tax is thought of as contributing to Medicare because of its title, the revenue goes into a general fund and is not earmarked for Medicare. According to the Joint Committee on Taxation's Description of the Social Security Tax Base (JCX-36-11), "No provision is made for the transfer of the tax from the General Fund of the United States Treasury to any Trust Fund."

Frequently asked questions

What type of tax is Medicare?

Medicare tax is a required employment tax that's automatically deducted from your paycheck. The taxes fund hospital insurance for seniors and people with disabilities.

What is the tax rate for Social Security and Medicare?

The FICA tax includes the Social Security tax rate at 6.2% and the Medicare tax at 1.45% for a total of 7.65% deducted from your paycheck.

What does it mean if you see a Medicare deduction on your paycheck?

This is a standard deduction, and it means that your employer is fulfilling its payroll responsibilities. This Medicare Hospital Insurance tax provides health care to seniors and people with disabilities.

What happens if your employer did not withhold Social Security and Medicare taxes?

Employers that do not adhere to tax laws by withholding FICA taxes for Social Security and Medicare could be subject to criminal and civil sanctions. If you see that no taxes have been withheld, check with your company to make sure there wasn't an error or that you didn't claim to be exempt on your W-4 form.

If you underpaid, you may have to pay a tax penalty at the end of the year. Also, if you are classified as an independent contractor rather than an employee, you'll pay taxes directly to the IRS rather than having them deducted by your employer.

What is a Medicare benefit tax statement?

This evidence of coverage statement confirms that you have enrolled in Medicare Part A and have health insurance that meets the Affordable Care Act requirements. Also called a 1095-B, this statement can be used if the IRS asks you to verify your health insurance coverage.

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