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December 10, 2012

HRB 59 - Additional Medicare Tax - Clarifications and Proposed Regulations Issued

Released December 10, 2012 I Download as a PDF

December 10, 2012 -- Two provisions of the Affordable Care Act (ACA) that will take effect soon, specifically on or after January 1, 2013, relate to new Medicare taxes.  One imposes a 0.9% increase in the amount of Medicare tax paid by high income earners; the other imposes a 3.8% tax on investment income. 

The IRS and Treasury Department have released implementing guidance on this Medicare tax in the form of proposed regulations and questions and answers..  Comments on both sets of proposed regulations must be received by March 5, 2013.  Following are highlights of this guidance.

Medicare Tax on High Earners

As background, the ACA imposes an increase in Medicare tax for high wage earners to help fund expanding access.  The Medicare tax increase, which takes effect January 1, 2013, imposes a 0.9% increase in the individual’s Medicare tax rate, applicable on earnings in excess of $200,000 in a calendar year (see CBIZ Health Reform Bulletin, Implementation Guidance on Medicare Tax, 6/27/12). 

The proposed regulations and additional questions and answers are intended to provide implementation guidance specific to employers and payroll vendors, as well as individuals.

Below is a chart of individuals liable for the additional tax, based on their filing status:

Filing Status

Income Threshold Amount

Single

$200,000

Married filing jointly

$250,000

Married filing separately

$125,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$200,000

The employer must begin withholding the additional Medicare tax beginning at the point the individual’s income reaches the $200,000 threshold, without regard to whether they will ultimately be subject to the tax.  For timing purposes, the withholding begins in the pay period in which the individual’s income exceeds the threshold amount.

The additional 0.9% withholding is required on all wages subject to Medicare in excess of $200,000  Income, for these purposes, means an individual’s total wages, including taxable noncash fringe benefits (see IRS Publication 15, Employer’s Tax Guide, for additional information on calculating withholding on taxable noncash fringe benefits). 

There is no employer match or contribution for the additional tax withheld.  Employers are not only obligated to withhold the tax even if employees may not be liable for the additional Medicare tax, but employers would be required to pay the tax if it fails to withhold the amounts, unless paid by the employee.

The proposed regulations clarify that an employee is liable for the additional Medicare tax on wages to the extent that the tax is not withheld by his/her employer. For example, if an employee and his/her spouse each had wages of $200,000 or less, such that their employers did not withhold the additional Medicare tax from individual’s wages, but their combined wages exceed the threshold for a joint return (i.e., $250,000), the employee and his/her spouse are liable to pay additional Medicare tax.

An employee who anticipates the additional Medicare Tax liability may request his/her employer to withhold an additional amount of tax on the Form W-4.

As noted in prior guidance, employers are not required to notify an employee when it begins withholding the additional tax. 

The Q&As outline special withholding rules and processes that apply in certain circumstances, such as when:

  • Income is derived from both wages and tips; or income is derived from both wages and third-party sick pay;
  • Income is derived from multiple subsidiaries, from related corporations, or from leasing companies.
  • Group-term life insurance coverage in excess of $50,000 and the cost of the coverage, in combination with other wages, exceeds $200,000 for terminated employees and retirees; and
  • Calculating the timing of deferrals to a nonqualified deferred compensation (NQDC) plan for purposes of determining threshold limits.

The IRS indicates that it will be revising the Form 941 for employers to report wages paid during the quarter exceeding the $200,000 threshold, as well as their withholding liability for tax on those wages.  Employers can correct any errors, interest-free, made in calculating the additional withholding tax, such as underpayments or overpayments, on the Form 941-X.  There are no anticipated changes to the Form W-2.

Net Investment Income Tax

Beginning January 1, 2013, a new additional 3.8% Medicare tax on net investment income is imposed on individuals, estates and trusts.  The IRS and Treasury Department released implementing guidance on this tax in the form of proposed regulations and questions and answers

Who is Subject to the Tax?

Individuals are subject to the additional tax if their net investment income and modified adjusted gross income (AGI) exceed the following thresholds:

Filing Status

Income Threshold Amount

Single

$200,000

Married filing jointly

$250,000

Married filing separately

$125,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$200,000

Estates and trusts are subject to the additional tax if they have undistributed net investment income and adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year ($11,650 for the 2012 tax year).

What is Investment Income?

For purposes of this tax, investment income includes: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer.  Certain gains are also taken into account in computing net investment income, such as:

  • Gains from the sale of stocks, bonds, and mutual funds;
  • Capital gain distributions from mutual funds;
  • Gain from the sale of investment real estate; and
  • Gains from the sale of interests in partnerships and S corporations (to the extent of certain built in gains in entity assets)..

Reporting the Income

The Form 1040 is used by individuals for reporting and paying the net investment income tax.  The tax applies to investment earnings in 2013, and is reported on the Form 1040 filed in 2014 for the 2013 year.  Estates and trusts will use the Form 1041 for reporting and paying the investment income tax.

Conclusion

Employers should begin working with their payroll services and payroll departments to make certain withholding can begin at the proper time.  While there is no obligation to notify employees of the additional withholding, the employer may wish to do so to avoid later questions.  It should be noted that while an individual may be subject to both the additional 0.9% wage tax and the 3.8% net investment income tax, the types of income on which they are assessed differ.

 

About the Author:  Karen R. McLeese is Vice President of Employee Benefit Regulatory Affairs for CBIZ Benefits & Insurance Services, Inc., a division of CBIZ, Inc.  She serves as in-house counsel, with particular emphasis on monitoring and interpreting state and federal employee benefits law.  Ms. McLeese is based in the CBIZ Leawood, Kansas office.

 

 

The information contained herein is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations. The information contained herein is provided as general guidance and may be affected by changes in law or regulation. The information contained herein is not intended to replace or substitute for accounting or other professional advice. Attorneys or tax advisors must be consulted for assistance in specific situations. This information is provided as-is, with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in connection with its use and assumes no obligation to inform the reader of any changes in laws or other factors that could affect the information contained herein. As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

 

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