If you’re healthy and younger than 65, you may not think much about Medicare. Even if Medicare doesn’t yet apply to you personally, small business owners should understand how the program works and is funded.
That’s because employers pay half of the Medicare tax for every employee. So it may affect your hiring decisions and your payroll as it relates to your responsibility for tax withholding.
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What is the Medicare tax rate?
Medicare is a joint federal and state program that provides health services to millions of people in the US.
It helps more people get access to health care, regardless of their age or medical status. To be eligible for Medicare, you must be 65 years of age or older, younger with certain medical conditions, or a patient with end-stage renal disease.
The program is divided into four parts, the first two of which are also called Original Medicare:
- Part A is hospital insurance for stays at a hospital or skilled nursing facility, nursing home care, hospice care, and home health care.
- Part B is medical insurance that covers two types of services: necessary care to diagnose or treat a medical condition, as well as preventive care. Covered services include ambulances, mental health, clinical research, some medical equipment, and limited prescription drugs.
- Part D is prescription drug coverage insurance. Each Medicare plan has its own list of covered medications, and drugs are typically placed into different cost tiers.
- Medicare Advantage, also called Part C, are Medicare-approved plans from private companies that bundle Part A, Part B, and usually also Part D. Some of these plans may offer coverage for services such as vision, hearing, dental, or wellness.
Of course, supplying all of these health services requires money. People with Medicare plans generally pay premiums for coverage, but most of the funding comes from workers who pay Medicare tax—and from their employers, who pay a share of it, too. That’s where you, the business owner, come in.
How the Medicare tax rate is calculated
Medicare taxes are payroll taxes automatically withheld from an employee’s paycheck. As of 2023, the total Medicare tax rate is 2.9% of an employee’s eligible compensation, according to the Internal Revenue Service. In most situations, half of the Medicare payroll tax (1.45%) is paid by the employee, and half is paid by the employer.
On an employee’s pay stub, this figure will appear as part of Federal Insurance Contributions Act (FICA) taxes, which comprise both Social Security tax and Medicare tax.
So if you pay your employee $70,000 a year in earnings subject to Medicare tax, here’s how you’d calculate it:
$70,000 x 1.45% = $1,015
That means you’re required to withhold $1,015 annually from your employee’s paycheck for Medicare tax, and you as the employer will pay an additional $1,015, for a total of $2,030, or 2.9% of your worker’s Medicare-eligible wages.
Unlike Social Security taxes, there’s no wage base limit for Medicare tax. All covered wages are subject to Medicare tax.
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Exceptions and exemptions for Medicare tax
If any of your employees earned income of more than $200,000 in a calendar year, there’s an additional Medicare tax that helps fund the Affordable Care Act.
You, as the employer, are required to withhold 0.9% in Medicare tax liability on wages that exceed $200,000, regardless of the employee’s status as either single or joint filer. Whether they actually pay that additional tax depends on their status: Married couples filing jointly on their tax return will pay 0.9% on wages above $250,000, and married couples filing separately pay the surtax on earnings of more than $125,000. All other employees, including single filers, pay the extra tax on earnings of more than $200,000. This tax is paid only by the employee, not the employer.
Your employees who invest also must pay a net investment income tax (NIIT) of 3.8% of their net investment income, but just like the additional Medicare tax, you won’t pay any of this as the employer. According to the IRS, NIIT includes investment income like interest payments, stock dividends, capital gains, rental income, and more; it does not include individual retirement accounts, wages, unemployment compensation, operating income from a non-passive business or a self-employment business, Social Security benefits, or alimony.
Although compensation like salary, overtime, tips, and bonuses are subject to Medicare tax, not all income is counted in Medicare wages: Items such as Social Security benefits, pension payments, stock dividends, and interest from savings are exempt from FICA tax.
What to know about Medicare tax rate as an ecommerce business owner
Medicare tax considerations can affect your hiring and payroll decisions from both a financial and bookkeeping standpoint. You’re responsible for paying 1.45% of each employee’s eligible Medicare wages, so you’ll need to include that when planning your compensation budget.
From the payroll perspective, you’ll also have to withhold another 1.45% from paychecks for the employee portion (plus 0.9% of wages more than $200,000 paid to an employee in a calendar year). Companies that fail to pay Medicare tax may end up paying penalties and interest. What’s more, your employees may not receive the correct credit for their future Medicare coverage if you don’t pay the tax.
If you’re self-employed as a sole proprietor or as a partner in a partnership, you must pay the full 2.9% in Medicare tax yourself.
There are a few actions you can take as a small business owner to reduce Medicare tax liability, including:
- Offer your employees tax-advantaged retirement plans. This lets your employees contribute part of their paychecks to plans such as 401(k)s on a tax-deferred basis, which can reduce their taxable income. You as an employer may be able to contribute to their plans as well, which can give you additional tax benefits.
- File fortax credits. As a small business owner, you may be eligible for multiple tax credits that can help reduce your Medicare tax liability, such as the Small Business Health Care Tax Credit.
- Take advantage of tax deductions. You can claim some small business expenses as deductions to reduce your taxable income, including potentially the cost of supplies, travel, and some employee benefits.
Medicare tax rate FAQ
Does everyone pay the same Medicare tax rate?
As of 2023, most workers pay a Medicare tax rate of 1.45% and the employer pays an additional 1.45%. Self-employed workers are responsible for paying the full 2.9% Medicare tax on their self-employment income.
High earners pay a bit more, in what’s called an additional Medicare tax of 0.9% above eligible wages over certain thresholds.
How do you calculate additional Medicare tax in 2023?
Whether they actually pay additional Medicare tax does depend on their tax-filing status. Married couples filing jointly pay 0.9% on wages above $250,000, married couples filing separately pay the surtax on earnings of more than $125,000, and all others including single filers pay the additional tax on earnings of more than $200,000.
Can I opt out of the Medicare tax?
Otherwise, generally only members of certain religious groups—including Mennonites and the Amish—can choose to waive their rights to Medicare benefits and opt out of paying Medicare tax.
Do you get the Medicare tax back?
Why do I have to pay the Medicare tax if I have health insurance?
Note that when you’re eligible for Medicare, you can also opt to enroll in the program to supplement your private health insurance.