“HI” stands for hospital insurance, which is commonly referred to as Medicare. Medicare is the basic medical insurance program for people age 65 and older as well as with certain disabilities. Medicare has four different parts that each help with a specific benefit, such as inpatient care, outpatient care and prescription drug coverage.
Paying the Medicare and Social Security tax on your earnings throughout your lifetime makes you eligible for these benefits when you’re older. The HI tax is a tax on earned income that helps pay for these benefits.
Medicare Tax Rate for Employees
The Medicare tax rate is 2.9 percent total. However, when you work as an employee, the Medicare tax is split between you and your employer, at 1.45 percent equally. As a result, you’ll only see your paycheck reduced by 1.45 percent by Medicare tax withholding.
For example, if you receive a $1,000 paycheck, you’ll see $14.50 withheld for Medicare taxes. Some employers will also show that the company is paying an additional $14.50 on your behalf for Medicare taxes, but that $14.50 paid by your employer doesn’t affect your take-home pay.
Medicare Tax Rate for Self-Employed
If you’re self-employed, you’re considered both the employer and the employee for the Medicare taxes. As a result, you’re responsible for paying the entire 2.9 percent tax by yourself. You might think that this is unfair because an employee doesn’t have to count the employer’s Medicare tax payments as taxable income.
However, it works out because when you’re calculating self-employment taxes, you first multiply your net self-employment income by 0.9235, which exempts 7.65 percent of your net self-employment income from self-employment taxes. This is the same percentage that employers pay on behalf of employees for both the Medicare tax and the Social Security tax, which is the other tax included in payroll taxes and self-employment taxes.
No Limit on Medicare Tax
There is no limit on the amount of earned income subject to Medicare taxes. Earned income includes income from working, like wages, salaries, bonuses and self-employment income. So, whether you have a $50,000 or $5 million salary, $15,000 or $1.5 million bonus, or side hustle that makes you $1,000 or $100,000, it’s all subject to Medicare taxes.
This is different than the Social Security tax portion of payroll and self-employment taxes, which are capped each year at what is known as the contribution and benefit base. This is the maximum amount of earned income that is subject to the Social Security tax. For example, in 2021, the Social Security contribution and benefit base is $142,800. That means that if you have a $158,400 salary, you’ll pay Medicare tax on the entire amount, but the last $15,600 won’t be subject to the Social Security tax.
Where the Medicare payroll tax and the Social Security payroll tax are the same is that neither applies to unearned income. So, you won’t have to pay either tax on income like interest, dividends, capital gains or retirement plan distributions. For example, if you sell a stock you’ve been holding for a while and make a $5,000 profit, you won’t have to pay the Medicare tax on those proceeds.
Additional Medicare Tax
If you’re making a lot of money during the year, you could find yourself subject to not only the Medicare tax, but also the Additional Medicare Tax. The Additional Medicare tax is a 0.9 percent tax that applies to earned income in excess of the threshold amount for your filing status. For 2020, the thresholds are $250,000 for married couples filing jointly and $200,000 for single filers, heads of household and widows and widowers with a qualifying child.
This tax isn’t split between you and your employer, like the normal Medicare tax. As a result, you will pay 2.35 percent yourself on any earned income above the threshold amount. For example, if you are single and your salary is $240,000, both you and your employer will each pay 1.45 percent in Medicare taxes on the first $200,000 of your income. Then you’ll pay 2.35 percent and your employer will pay 1.45 percent in Medicare taxes, including the Additional Medicare Tax, on the last $40,000 of your salary because that is the portion in excess of the threshold for your filing status.
Depending on your work and family status, you could find yourself in a situation where the Additional Medicare Tax is either withheld when you won’t owe it or not withheld when you expect to owe it because your employer will start withholding for the Additional Medicare Tax once your earnings exceed $200,000, regardless of your tax filing status.
Overpaying the Additional Medicare Tax
For example, if you are married and will file a joint return, your income threshold is $250,000. If you are the sole wage earner and your salary is $220,000, your employer may withhold the 0.9 percent Additional Medicare Tax from the last $20,000 of your salary because you’re over the $200,000 withholding threshold. You cannot request that your employer not withhold the tax, but you will receive the excess back as a tax refund when you file your return.
Alternatively, you could owe the Additional Medicare Tax even if your employer isn’t required to withhold it from your paychecks. For example, say both you and your spouse work and both have a salary of $190,000. Because neither of you is over the $200,000 threshold for withholding, neither of your employers will withhold portions of your paycheck for the Additional Medicare Tax. However, because your combined salaries are $380,000, you will owe the Additional Medicare Tax when you file your taxes regardless of how you file. If you file jointly, you will owe because your combined income exceeds the $250,000 threshold for married couples filing jointly.
If you file as married filing separately, you each are well over the $125,000 threshold for taxpayers who are married but file separate returns. You can’t request that your employer withhold additional amounts specifically for the Additional Medicare Tax, but you can request additional withholding generally from your paycheck to cover the anticipated tax liability or make estimate tax payments yourself.
Exemptions from Medicare Tax
Generally speaking, the Medicare tax applies to earned income in the United States, and in limited circumstances, outside of the United States, regardless of whether you are a citizen or not, and regardless of whether the company you work for is an American company or not. However, there are a few circumstances where income isn’t subject to Medicare taxes.
First, the student exception to FICA taxes exempts income earned by students who are working at a school, college or university where they are also studying. To qualify for the exemption, the employee’s primary relationship with the school must be education. For example, if you work full-time as a professor at a university, but also take one course each semester in an unrelated subject area or sit in on seminars, your primary relationship with the university is employment, not education, and your wages would still be subject to the Medicare tax.
Alternatively, if you are a full-time student and you have a work-study job in the dining hall or work for one of your professors as a research assistant, your wages would be exempt from the Medicare tax.
Retirement Plan Considerations
Second, when your employer makes retirement plan contributions to your plan on your behalf, those contributions aren’t subject to the Social Security tax or Medicare tax. This does not include contributions that you make to your retirement plan through your employer.
For example, if you contribute $10,000 to your 401(k) plan and your employer matches 50 percent, or $5,000, you will still pay the Medicare tax on the $10,000 you deferred into your 401(k) plan, but the $5,000 your employer contributed on your behalf is exempt from the Medicare tax. This exemption does not apply to individual retirement accounts. For example, if you contributed $5,000 to your traditional IRA, that doesn’t reduce the amount of Medicare taxes you pay during that year.
Third, the Medicare tax doesn’t apply to health insurance paid by your employer. For example, if your employer pays $200 each month toward your medical insurance premiums, you won’t have to pay the Medicare tax on that $200 benefit. However, this exception only applies when the benefits are paid by your employer. If you paid for the medical insurance yourself, those amounts are still subject to the Medicare tax. For example, if you paid instead of your employer paying the $200 on your behalf, then you will have Medicare taxes withheld on that $200 of wages.
Paying the HI Tax
Most people pay the FICA HI tax through paycheck withholding from their employer. Their employer simply withholds the tax from their paycheck and diverts it to the IRS to pay the tax bill. Because the Medicare tax hits virtually all of your income, and is not subject to the same tax deductions as income taxes, it’s uncommon to not have your Medicare taxes withheld match your liability.
For example, if your salary is $52,000 but you qualify for a $1,000 student loan interest deduction and a $3,000 deduction for your IRA contribution, you will still owe Medicare taxes on the full $52,000 even though you will only have $48,000 in taxable income for income tax purposes.
However, if you are self-employed and don’t have the Medicare tax withheld from your paycheck, you will usually need to make estimated tax payments throughout the year to avoid an underpayment penalty when you file your taxes at the end of the year.
Generally speaking, to avoid a penalty, your withholding and estimated payments during the year must equal at least 90 percent of your total tax liability for the current year or 100 percent of your total tax liability for the prior year. If you are considered a higher income taxpayer, which means your adjusted gross income exceeds $150,000 (or over $75,000 if you’re married filing separately), your withholding must exceed 110 percent of your total tax liability from the prior year to satisfy the safe harbor.
What to Include as Tax Liability
Your total tax liability includes both your income taxes and your self-employment taxes, including the Medicare tax. For example, say that last year your income taxes were $8,000 and your self-employment taxes, including Medicare taxes, totaled $6,000 and this year your income taxes are $8,500 and self-employment taxes are $6,200.
To meet the safe harbor to avoid penalties for underwithholding based on last year’s income taxes, your withholding and estimated tax payments would need to be at least $14,000, unless you were a higher income taxpayer, in which case it would increase to $15,400. That is, 110 percent of the prior year’s tax return. Or, you could use 90 percent of this year’s tax liability, which is $13,230.
If your tax liability stays relatively constant from year to year, the 90 percent threshold for the current year’s tax liability will often be the lower amount. However, it can be hard to predict what you’ll owe from year to year, and an unexpected jump in your income could throw off your estimated payments completely. To avoid running into that issue, many taxpayers use the safe harbor based on the prior year’s tax liability to plan their estimated payments, knowing they’re covered regardless of what happens with their income. And, if they end up overpaying because of a down year, the excess comes back to them as a tax refund.
- Social Security Administration: FICA and SECA Tax Rates
- Social Security Administration: Contribution and Benefit Base
- IRS: Social Security Tax / Medicare Tax and Self-Employment
- IRS: Questions and Answers for the Additional Medicare Tax
- IRS: Student Exception to FICA Tax
- IRS: Retirement Plan FAQs Regarding Contributions - Are Retirement Plan Contributions Subject to Withholding for FICA, Medicare or Federal Income Tax?
- IRS: Topic Number 306 - Penalty for Underpayment of Estimated Tax
- Social Security Administration: Understanding the Benefits
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."