What is Medicare tax?
The Medicare tax is a federal tax that is used to fund the Medicare program, which provides health insurance to individuals aged 65 and older, as well as certain younger individuals with disabilities or specific medical conditions. Both employees and employers contribute to this tax, which is automatically withheld from wages and remitted to the IRS. For most employees, the Medicare tax rate is a fixed percentage of their income, though there are additional considerations for higher earners.
In payroll, the Medicare tax is an essential part of an employee’s withholding, and employers are responsible for matching this contribution. As a business owner, understanding the ins and outs of Medicare tax will help you ensure compliance, avoid costly mistakes, and keep your payroll running smoothly.
Why Medicare tax matters for employers
Medicare tax is a mandatory federal payroll tax that directly impacts your employees’ take-home pay, your business’s tax liabilities, and your compliance with federal tax laws. Here’s why employers need to understand:
1. Legal compliance
Medicare tax is mandated by the Federal Insurance Contributions Act (FICA), and failing to withhold and remit it properly can lead to serious consequences, including penalties and back payments. Employers are required by law to withhold the appropriate Medicare tax from employee wages and match it with an employer contribution.
2. Financial implications for your business
Medicare tax is one of the costs that employers must factor into their payroll expenses. The total tax burden is shared between the employer and the employee, and as an employer, you’re responsible for paying an amount equal to what your employees contribute.
3. Impact on employee benefits
Medicare tax is directly linked to employee benefits under the Medicare program. The more an employee contributes over the years, the more likely they are to qualify for full Medicare benefits upon retirement or when they become eligible due to disability.
How Medicare tax is calculated
Medicare tax is calculated as a percentage of an employee’s wages, with no upper income limit for withholding. The tax is split into two parts:
- Employee contribution: Employees contribute 1.45% of their taxable wages to Medicare tax.
- Employer contribution: Employers match the 1.45% contribution, for a total of 2.9%.
This tax is automatically withheld from employees' paychecks by the employer. The total 2.9% is remitted to the IRS, with half coming from the employee and half from the employer.
Additional Medicare tax for higher earners
In addition to the standard 1.45%, high-income earners may be subject to an additional 0.9% Medicare tax. This extra tax is applied to wages exceeding $200,000 for individuals or $250,000 for married couples filing jointly. Employers are only required to withhold this additional tax from employees' wages once they exceed the $200,000 threshold, and they are not required to match it.
Legal and compliance considerations
Medicare tax is subject to federal laws, and employers must ensure compliance to avoid penalties. Here are some key legal considerations for employers:
- FICA requirements — Under FICA, employers are obligated to withhold 1.45% from employees’ wages and match it. Failure to comply could result in severe penalties, including back taxes, interest, and fines.
- Additional Medicare tax — For high earners, the 0.9% additional Medicare tax must be withheld on wages exceeding $200,000. This tax applies only to employees; employers do not match this portion.
- State and local considerations — While Medicare tax is a federal tax, it’s important to remember that some states and local governments may have their healthcare-related taxes that affect employee pay. You’ll need to stay aware of any other payroll-related taxes to ensure full compliance.
Common mistakes to avoid
Avoiding these common pitfalls will help you stay compliant and prevent costly errors when managing Medicare tax withholdings.
1. Failing to withhold the additional 0.9% tax for high earners
One common mistake is not applying the additional 0.9% Medicare tax to employees earning more than $200,000. Employers are responsible for withholding this extra tax once the employee hits the $200,000 threshold. Be sure to track this carefully to avoid underpayment.
2. Not correctly matching the employer contribution
Employers are responsible for matching the 1.45% Medicare tax for every employee. Failing to do so, even if the employee’s contribution is correct, can result in penalties and interest from the IRS.
3. Incorrectly classifying payments as “non-taxable”
Some types of compensation, such as bonuses or certain fringe benefits, are subject to Medicare tax but may be overlooked. Be sure to include all forms of employee income when calculating the tax.
4. Miscalculating tax on severance pay or retirement benefits
Severance pay and retirement plan distributions are subject to Medicare tax. Employers should ensure that these forms of compensation are included in their payroll calculations, especially when employees receive large lump sums upon termination.
How Homebase helps with Medicare tax compliance
Homebase Payroll ensures that your business stays compliant with Medicare tax requirements. With automated calculations for employee and employer Medicare tax contributions, Homebase makes it easy to manage payroll without worrying about the complexities of tax withholding.
Here’s how Homebase helps:
- Accurate Medicare tax calculations for all employees, including additional tax for high earners
- Automated withholding for the 1.45% Medicare tax and 0.9% additional tax
- Real-time payroll previews to catch errors before payday
- Tax filing automation to ensure accurate and timely submission to the IRS
- Seamless integration with accounting and tax systems to maintain proper records and compliance
Explore Homebase Payroll to automate your payroll process, ensure Medicare tax compliance, and reduce the risk of costly errors.