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An In-Depth Look: The Additional .9% Medicare Tax
(Parker's Federal Tax Bulletin: December 7, 2012)

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The Affordable Care Act added Code Sec. 3101(b)(2), which increases the employee portion of Medicare tax for wages received in any tax year beginning after December 31, 2012, by an additional 0.9 percent of Federal Insurance Contribution Act (FICA) wages and Railroad Retirement Tax Act (RRTA) wages in excess of certain threshold amounts.

This additional Medicare tax differs from the current Medicare tax in that it is not imposed until wages, compensation, and self-employment income exceed a threshold amount, and the threshold amount for applying the tax is based on the individual's filing status. Thus, the additional Medicare tax is not based on a taxpayer's adjusted gross income.

Under Code Sec. 3101(b)(2), the threshold amount is $250,000 in the case of a joint return, $125,000 in the case of a married taxpayer filing a separate return, and $200,000 in any other case. The additional .9 percent Medicare tax also differs from the current Medicare tax in that there is no employer portion to correspond to the amount owed by the employee.

On Friday, November 30, the IRS issued proposed regulations (REG-130074-11) that provide guidance for employers and individuals on the implementation of the additional Medicare tax, including the requirement to withhold the tax on certain wages and compensation, the requirement to file a return reporting the tax, the employer process for adjusting underpayments and overpayments of the tax, and the employer and employee processes for filing a claim for a refund of the tax. The IRS has also posted on its website FAQs regarding the tax.

Compliance Tip: The regulations are proposed to be effective the date the regulations are finalized. The regulations under Code Secs. 1401, 3101, 3102, and 3202 are proposed to apply to quarters beginning after the date the final regulations are published in the Federal Register. The regulations under Code Sec. 6011 are proposed to apply to tax years beginning after the date the final regulations are published in the Federal Register. The regulations under Code Secs. 6205, 6402, and 6413 are proposed to apply to adjustments made and claims for refund filed after the date the final regulations are published in the Federal Register. The IRS stated that it intends to finalize the proposed regulations in 2013. Taxpayers may rely on the proposed regulations for tax periods beginning before the date the final regulations are published in the Federal Register.

Employer's Withholding Obligation

The proposed regulations describe the extent to which an employer is required to withhold the additional Medicare tax. An employer must withhold the additional Medicare tax from an employee's wages only to the extent the employee receives wages from the employer in excess of $200,000 in a calendar year. In determining whether wages exceed $200,000, an employer does not take into account the employee's filing status or other wages or compensation that may impact the employee's liability for the tax.

Further, the proposed regulations provide that to the extent the additional Medicare tax is not withheld by the employer, the employee is liable for the tax. The proposed regulations also provide that the IRS will not collect from an employer the amount of the additional Medicare tax it failed to withhold from wages paid to an employee if the employee subsequently pays the additional Medicare tax. However, the proposed regulations also specify that the employer remains subject to any applicable penalties or additions to tax for failure to withhold the additional Medicare tax as required. Similar rules apply to railroad employers.

Practice Tip: An employee cannot request that the employer deduct and withhold the additional Medicare tax on compensation of $200,000 or less. Instead, an employee who anticipates liability for the additional Medicare tax may request that the employer deduct and withhold an additional amount of income tax withholding on Form W-4, Withholding Allowance Certificate, to apply against taxes shown on Form 1040, including any additional Medicare tax liability.

Employee Reporting and Paying of the Additional Medicare Tax

The proposed regulations provide that an employee is liable for the additional Medicare tax on wages or compensation to the extent that the tax is not withheld by the employee's employer. Under the proposed regulations, an individual must report the additional Medicare tax on Form 1040. An individual claims credit for any withheld additional Medicare tax on Form 1040 and pays with Form 1040 any such tax due that was not previously paid through withholding or estimated tax.

Example: If an employee and his or her spouse each had wages of $200,000 or less, such that their employers did not withhold the additional Medicare tax from the employee's or the spouse's wages, but the combined wages of the employee and the employee's spouse exceed the threshold for a joint return (i.e., $250,000), the proposed regulations provide that the employee and the employee's spouse are liable to pay the additional Medicare tax.

Self-Employed Individual's Obligation to Pay the Additional Medicare Tax

Code Sec. 1401 imposes social security and Medicare taxes on the self-employment income of every individual at the same combined employer and employee rates applicable under the FICA. The Affordable Care Act added Code Sec. 1401(b)(2). Code Sec. 1401(b)(2)(A) increases the Medicare tax on self-employment income for any tax year beginning after December 31, 2012, by an additional 0.9 percent of self-employment income that is in excess of certain threshold amounts previously mentioned.

The proposed regulations describe the extent to which an individual who has self-employment income is liable for the additional Medicare tax. Specifically, the proposed regulations describe how the applicable threshold amounts are reduced (but not below zero) by the amount of FICA wages taken into account in determining the additional Medicare tax liability. Thus, the proposed regulations illustrate the application of the reduced threshold amounts for purposes of determining liability for the additional Medicare tax attributable to the individual's self-employment income.

Example: Carl, a single filer, has $130,000 in wages and $145,000 in self-employment income. Carl's wages are not in excess of the $200,000 threshold for single filers, so Carl is not liable for the additional Medicare tax on these wages. Before calculating the additional Medicare tax on self-employment income, the $200,000 threshold for single filers is reduced by Carl's $130,000 in wages, resulting in a reduced self-employment income threshold of $70,000. Carl is liable to pay the additional Medicare tax on $75,000 of self-employment income ($145,000 in self-employment income minus the reduced threshold of $70,000).

Example: Dave and Emily are married and file jointly. Dave has $150,000 in wages and Emily has $175,000 in self-employment income. Dave's wages are not in excess of the $250,000 threshold for joint filers, so Dave and Emily are not liable for additional Medicare tax on Dave's wages. Before calculating the additional Medicare tax on Emily's self-employment income, the $250,000 threshold for joint filers is reduced by Dave's $150,000 in wages resulting in a reduced self-employment income threshold of $100,000. Dave and Emily are liable to pay the additional Medicare tax on $75,000 of self-employment income ($175,000 in self-employment income minus the reduced threshold of $100,000).

Example: Gina, a head of household filer, has $225,000 in wages and $50,000 in self-employment income. Gina's employer withheld additional Medicare tax on $25,000 ($225,000 minus the $200,000 withholding threshold). Gina is liable to pay the additional Medicare tax on $25,000 of her wages ($225,000 minus the $200,000 threshold for head of household filers). Before calculating the additional Medicare tax on self-employment income, the $200,000 threshold for head of household filers is reduced by Gina's $225,000 in wages to $0 (reduced, but not below zero). Gina is liable to pay the additional Medicare tax on $50,000 of self-employment income ($50,000 in self-employment income minus the reduced threshold of $0). In total, Gina is liable to pay the additional Medicare tax on $75,000 ($25,000 of her wages and $50,000 of her self-employment income). The additional Medicare tax withheld by Gina's employer is applied against all taxes shown on her individual income tax return, including any additional Medicare tax liability.

The Affordable Care Act did not provide for a reduction in the self-employment income threshold amounts by the amount of any RRTA compensation taken into account in determining liability for the additional Medicare tax. Thus, an individual who receives both RRTA compensation and self-employment income does not reduce the self-employment income threshold amounts by the amount of RRTA compensation taken into account in determining the additional Medicare tax liability.

Estimated Taxes

Under Code Sec. 6654, an addition to tax is imposed in the case of an individual's underpayment of estimated tax. Generally, the addition to tax imposed under Code Sec. 6654 does not apply to individuals who have sufficient income tax withholding on wages or who make estimated tax payments throughout the year. Under Code Sec. 6654(m), which was added by the Affordable Care Act, the additional Medicare tax is treated as a tax subject to estimated tax payment requirements.

Practice Tip: Employees may request additional income tax withholding on wages on Form W-4, Withholding Allowance Certificate, to reduce the need to make estimated tax payments to cover the individual's tax liability. In the case of employees, the additional Medicare tax is collected through withholding on FICA wages or RRTA compensation in excess of $200,000 in a calendar year. In addition, employees may request additional income tax withholding on wages on Form W-4 and use this additional income tax withholding to apply against taxes shown on their return, including any additional Medicare tax liability. To the extent not withheld, the additional Medicare tax must be included when making estimated tax payments.

Interest-Free Adjustments of the Additional Medicare Tax

The proposed regulations provide that adjustments of underpayments of the additional Medicare tax may be made only if the error is determined in the same year the wages or compensation was paid, unless: (1) the underpayment is attributable to an administrative error, (2) Code Sec. 3509 applies to determine the amount of the underpayment, due to the employer's failure to treat the individual as an employee, or (3) the adjustment is the result of an IRS examination.

Similarly, the proposed regulations under Code Sec. 6413 provide that an adjustment of an overpayment of the additional Medicare tax may be made only if the employer ascertains the error in the year the wages or compensation was paid and repays or reimburses the employee the amount of the overcollection before the end of the calendar year. As in the case of all overpayment adjustments, the requirement to repay or reimburse does not apply to the extent that, after reasonable efforts, the employer cannot locate the employee. However, if an employer has not repaid or reimbursed the amount of the overcollection to the employee, an adjustment cannot be made.

Claims for Refund of the Additional Medicare Tax

The proposed regulations provide a process by which employers and employees may claim refunds of overpayments of the additional Medicare tax. Under the proposed regulations, employers may claim refunds of overpaid additional Medicare tax only if the employer did not deduct or withhold the overpaid additional Medicare tax from the employee's wages or compensation. For employees, the proposed regulations eliminate the requirements that the employee first seek a refund from the employer and provide a statement in support of the employee's claim.

The proposed regulations direct the employee to claim the refund or credit of overpaid additional Medicare tax by taking the overpayment into account in claiming a credit against, or refund of, tax on an individual tax return (for example, Form 1040) for the year in which the overpayment was made, or for a tax year for which a tax return has been filed, by filing Form 1040X, Amended U.S. Individual Income Tax Return. This process is in lieu of filing a claim for refund for overpaid additional Medicare tax on Form 843, Claim for Refund and Request for Abatement. Employees may claim a refund of the additional Medicare tax only if they have not received repayment or reimbursement from their employer in the context of an interest-free adjustment

(Staff Editor at Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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