Before tax season begins, high-income clients may be seeking clarity on the new taxes introduced this year as part of the federal health-care reform law.
Some clients may be subject to the new 3.8% surtax on net investment income as well as an additional 0.9% Medicare payroll tax. These taxes apply to individuals with income over $200,000 and couples with income exceeding $250,000.
To learn more about the investment income surtax, read the education piece, “Planning for the 3.8% Medicare investment income surtax.”
Income thresholds trigger higher Medicare payroll tax
Some facts to highlight about the Medicare payroll tax:
- The current Medicare payroll tax is 1.45%
- The tax applies to wages, compensation, and self-employment income
- There is no earnings limit, unlike Social Security, which only applies to the first $113,700 of income.
- The Affordable Care Act introduced an additional 0.9% tax once earned income exceeds $200,000 for individuals and $250,000 for married couples, bringing the effective tax rate above those thresholds to 2.35%.
Withholding issues may cause confusion at tax time
Since this payroll tax applies differently to individuals and married couples, there will likely be some confusion with tax filing as the employer withholding may be insufficient. In the case of a married couple, the employer of one spouse does not have information on the compensation of the other spouse. Additionally, an individual may earn more than $200,000 in wages from multiple employers, but not earn more than that amount from any one of those employers.
Here’s an example highlighting a potential issue with employer withholding.
- A husband earns $200,000 in wages, which do not exceed the threshold, so the additional 0.9% payroll tax is not withheld.
- His wife earns $150,000 in wages, which does not meet the threshold and does not trigger the additional tax for withholding.
- Together, the couple earns $350,000, which is above the threshold of $250,000
- When filing taxes, the couple would owe an additional $900 in payroll taxes to satisfy the additional 0.9% Medicare tax.
IRS guidance for employers
The Internal Revenue Service offers guidance for employers as part of “Questions and Answers for the Additional Medicare Tax.” Under individual questions, the IRS notes, “An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual’s filing status or wages paid by another employer. An individual may owe more than the amount withheld by the employer, depending on the individual’s filing status, wages, compensation, and self-employment income. In that case, the individual should make estimated tax payments and/or request additional income tax withholding using Form W-4, Employee’s Withholding Allowance Certificate.”
If you have clients who fit this profile, whether high-earners or small business owners, you may want to direct them to their tax professional for guidance.