Reviewing the ACA’s 0.9% additional Medicare tax

As the year progresses, employers will need to begin withholding an extra 0.9% from the wages of more and more high-earners for the additional Medicare tax. This Affordable Care Act (ACA) provision went into effect last year. However, nothing is simple when it comes to new taxes.

Eleven months after the Jan. 1, 2013, effective date, the IRS issued final regulations to lay out the rules in excruciating detail. Then, earlier this summer, the agency produced a more user-friendly explanation of how it all works. Let’s review some important aspects of the additional Medicare tax that employers need to be aware of.

Income Thresholds

The tax is applied only to amounts exceeding certain income thresholds. The threshold amounts for the various categories of taxpayers are high enough so that they won’t be applicable to most employees. But they break down as follows:

Filing status Income threshold
Single $200,000
Head of household $200,000
Married filing jointly $250,000
Married filing separately $125,000

The thresholds encompass all traditional FICA wages and net self-employment income for U.S. citizens working either in the country or abroad.

Taxable wages not paid in cash, such as noncash fringe benefits, may be included in the income base for purposes of this tax because they’re taxable to employees. However, “statutorily excluded” fringe benefits generally aren’t included in taxable income or subject to employment tax, including the additional Medicare tax. Some examples are cell phones, commuting benefits and group term life insurance cost for up to $50,000 of coverage. But keep in mind that additional rules and limits apply.

Flexible Spending Accounts

How do the rules apply to contributions on an employee’s behalf to a Flexible Spending Account (FSA)? The answer is: “It depends.”

The value of qualified cafeteria benefits bought by an employee with employer contributions to the plan isn’t subject to the additional Medicare tax until the plan’s value exceeds $2,500. The plan’s cash amount isn’t subject to the tax either — even if the employee chooses simply to let those dollars sit in the FSA and not use them to buy eligible benefits. Benefits that can be purchased through a cafeteria plan include:

  • Accident and health benefits (except Archer Medical Savings Accounts),
  • Group term life insurance coverage, including cost that cannot be excluded from wages,
  • Dependent care assistance,
  • Adoption assistance, and
  • Long-term care insurance premiums or qualified long-term care services.

The value of benefits bought via an FSA that favors highly compensated or key employees, however, isn’t shielded from income tax in general or from the additional Medicare tax. For these purposes, highly compensated employees include:

  • Corporate officers (regardless of income),
  • Shareholders holding more than 5% percent of the company’s value or voting power of all classes of employer stock,
  • “An employee who is highly compensated based on the facts and circumstances,” according to the IRS, and
  • A spouse or dependent of someone included in the preceding three points.

In addition, those who own at least 1% of the company and whose annual pay exceeds $150,000 are typically included under the “key employee” definition.

Withholding Rules

Employers don’t need to begin withholding the additional Medicare tax until the first pay period during which wages for the calendar year exceed $200,000. The $200,000 withholding threshold is strictly based on employee compensation, not tax filing status.

If, because of his or her filing status, an employee will end up with a liability not covered by withholding (such as a married employee filing a separate return), he or she bears the responsibility of making estimated payments to make up the difference. Alternatively, that employee can ask the employer to increase the income tax withholding amount using a W-4 form.

It’s not permissible, however, to do the opposite. Suppose, for example, a married employee with an unemployed spouse is planning to file a joint return and is earning $240,000. The employer must withhold the additional 0.9% on $40,000 — that is, the excess over $200,000 — even though the threshold for joint filers is $250,000.

The employee in that scenario cannot request exemption from the withholding on that $40,000. But when the employee and spouse file their tax return, the excess withholding amount ($360, in this example) can be applied as a credit to their overall tax liability. IRS Form 8959 was created for this purpose.

Basic Understanding

Whether you handle your company’s payroll in house or use a payroll services provider, it’s important to understand the basics of the additional Medicare tax. If you suspect you’ve underwithheld amounts or you have any questions about the tax whatsoever, consult your tax advisor.

© 2014