28.4 Additional Medicare Taxes Take Effect in 2013

The Supreme Court decision upholding the constitutionality of the tax provisions in the 2010 Patient Protection and Affordable Care Act allows several tax changes to take effect as scheduled on January 1, 2013. There has been political opposition to the additional Medicare taxes discussed below and the itemized deduction and FSA changes noted in the Law Alert on this page, and there may be efforts to repeal them following the 2012 elections. See the e-Supplement jklasser.com for further details and developments.

Law Alert

2013 Changes to Medical Expenses and FSAs

The 2010 Patient Protection and Affordable Care Act raises the medical expense deduction floor and restricts the amount that can be contributed to a health care flexible spending account.

The current 7.5% AGI floor for deducting medical expenses will rise to 10% in 2013. However, those age 65 and older can continue to use the 7.5% floor until 2017 (17.1).

For 2012 and prior years, companies set the limits on employee salary-reduction contributions to health care flexible spending accounts (FSAs). Starting in 2013, the law limits an employee’s FSA contributions to $2,500. For years after 2013, the $2,500 limit will be subject to inflation adjustments (3.16).

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Additional 0.9% Medicare tax on earnings.

Whether you are an employee or are self-employed, if your earnings exceed a threshold tied to your 2013 filing status, you will owe an additional Medicare tax of 0.9%. This is on top of the basic Medicare tax otherwise due. Liability for the tax does not depend on your adjusted gross income. Only earnings above the following thresholds are subject to the additional tax:

• $250,000 for married persons filing jointly
• $200,000 for single persons, heads of households and qualifying widows(ers)
• $125,000 for married persons filing separately

Although the additional tax applies to the portion of earnings over the threshold, employers will only withhold the additional Medicare tax once wages (including tips, bonuses, and other taxable compensation) exceed $200,000. For a married couple filing jointly, the tax will be withheld from a spouse’s wages over $200,000 even if their combined wages do not exceed the $250,000 threshold, in which case the withheld tax will be applied against their total tax liability when they file their return. To the extent that the tax is owed but is not withheld from wages, it will have to be paid when the 2013 tax return is filed and could be subject to an estimated tax penalty (27.2) if not covered by income tax withholdings or estimated tax installments.

Self-employed individuals will have to pay the additional 0.9% tax with their 2013 return and should take it into account in figuring their estimated tax payments. The above-the-line deduction for the employer-equivalent portion of self-employment tax (45.3-45.4) will not apply to the additional 0.9% Medicare tax.

Additional 3.8% Medicare tax on unearned income.

A Medicare tax of 3.8% on net investment income may also apply. The tax applies in 2013 to the lesser of (1) net investment income, or (2) modified adjusted gross income exceeding the applicable threshold of:

• $250,000 for married persons filing jointly and qualifying widows(ers)
• $200,000 for single persons and heads of households
• $125,000 for married persons filing separately

Investment income includes taxable interest, dividends, annuities, rents and royalties, capital gains, and passive income from partnerships and S corporations. A homeowner who sells his or her principal residence has investment income for purposes of the additional Medicare tax only to the extent that gain exceeds the applicable home sale exclusion (usually $250,000 for singles and $500,000 for joint filers). Allocable deductions reduce the investment income.

Certain types of income are excluded from the investment income category: distributions from IRAs and qualified retirement plans, income from partnerships and S corporations in which you materially participate, tax-exempt interest, and nontaxable veterans benefits.

There is no withholding for this 3.8% tax, which will be paid with 2013 returns. The tax should be factored into income tax withholding from wages (the withholding can be applied to cover the tax liability) and/or estimated taxes.

Caution

Withholdings May Not Cover 0.9% Additional Medicare Tax for 2013

Employees may be subject to the additional 0.9% Medicare tax for 2013 but not have the tax withheld from their pay because an employer will not withhold it unless the employee’s wages exceed $200,000. Thus, an employee with several jobs could have wages well over the applicable threshold but not have the tax withheld by any of the employers. In such a case, additional income tax withholding may be requested or estimated tax installments paid to avoid an estimated tax penalty when the tax is due with the 2013 return. The tax will apply to a married couple filing jointly with total wages over $250,000, but withholding will be taken only by an employer paying wages over $200,000. Thus, if one spouse has wages of $180,000 and the other has wages of $170,000, the 0.9% tax will not be withheld from either of them although their combined wages are $100,000 over the $250,000 threshold, so their tax of $900 (0.9% x $100,000 excess) will be due with their 2013 return. Similarly, a person with wages between $125,000 and $200,000 who is married and files separately will not have the 0.9% tax withheld from his or her pay, but the tax will apply on the 2013 return to the wages over $125,000, the floor for married persons filing separately.

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