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ACA Medicare Tax Increase - Employer Withholding Requirements

September 26, 2012

When the employee portion of the Medicare Tax increases by 0.9% in 2013, does the employer have to withhold that amount from payroll? How do we know who is a joint filer with income in excess of $250,000?

Yes, the employer will have a withholding obligation with respect to the ACA 0.9% Medicare Tax increase, and generally will have to withhold the tax on employee wages or compensation it pays to an employee in excess of $200,000 in a calendar year.

Effective January 1, 2013, new Code section 3101(b) as added by the ACA generally imposes an additional 0.9% of wages Medicare Tax to the extent an employee's wages and other compensation (together with that of his or her spouse if filing a joint return) exceed the applicable threshold (generally, $125,000 for married filing separately, $200,000 for single and head of household, and $250,000 for married filing jointly). For these employees, the Medicare tax rate increases from 1.45% to 2.35% for the employee's portion of the tax. (The employer's rate remains at 1.45%. We also note that in 2013, certain higher income taxpayers will also be subject to an additional 3.8% tax (new Code sec. 1411) on "net investment income" under another change made by the ACA.)

On June 11, the IRS posted 20 FAQs on its website providing informal guidance regarding the additional Medicare Tax. These FAQs are designed to assist employers and payroll service providers in making payroll systems changes. A brief overview of key points made in the FAQs is provided below.

  • An employer must withhold the tax on wages or compensation it pays to an employee in excess of $200,000 in a calendar year. The withholding must begin in the pay period in which the employer pays wages in excess of $200,000 to an employee. If a single payment of wages exceeds the $200,000 threshold, the employer must only withhold on the portion of the payment that exceeds the $200,000 threshold.
  • The employer does not have an obligation to notify the employee of the extra withholding. (The upcoming 2013 Form W-2 will likely require that the additional tax be aggregated on line 6 (Medicare Tax Withheld), and the Forms 941/943 likely will be revised to reflect the additional Medicare Tax.)
  • Among other things, the withholding applies to (1) noncash fringe benefits (subject to flexibility under the existing employment tax rules), (2) reported tips, (3) imputed income from group-term life insurance (subject to the special rules for retirees and other former employees), (4) third-party sick pay when the aggregate wages from the employer and the sick pay provider exceed the threshold (applying the regular rules for sick-pay reporting), and (5) nonqualified deferred compensation (NQDC) (following the complex special timing rules for NQDC under Code section 3121(v)).
  • If an employee works for multiple subsidiaries in an employer's controlled group, each subsidiary employer has its own withholding threshold, unless the employee is paid through a common paymaster arrangement (in which case, aggregation is required). Similarly, wages paid to an employee by an agent with approved Forms 2678 that is acting as an agent for multiple employers should not combine the wages.
  • An employee will have to report and pay the tax on the Form 1040 to the extent that the withholding was not sufficient (or to receive a refund of any excess tax withheld). An employee can modify his or her Form W-4 to withhold additional income tax (or pay estimated income taxes) to cover the additional Medicare tax, but cannot ask the employer to withhold additional Medicare tax.

This column appeared in Second Opinions, a weekly PlanSponsor feature to help plan sponsors understand what they need to do to prepare for the impact of the Patient Protection and Affordable Care Act.  Groom principals, Christy Tinnes and Brigen Winters, serve as the health care reform experts and field weekly questions regarding the new law.