Health Care Reform: Recent Guidance for Paying the Additional Medicare Tax Under the Affordable Care Act
Beginning on January 1, 2013, for employees whose compensation exceeds certain threshold amounts, an additional Medicare tax of 0.9% will be imposed on top of the current 1.45% that is the employee’s share of the hospital insurance portion of FICA. The Honigman Health Care Reform Alert, October 1, 2012 explained these threshold amounts and the employer’s duties with respect to withholding and reporting.
On November 30, 2012, the IRS issued proposed regulations that further address withholding, computation, reporting and payment of the Additional Medicare Tax, as well as procedures for making interest-free adjustments to correct overpayments or underpayments. These new rules will apply to quarters beginning after the publication of the final regulations in the Federal Register.
Though perhaps not of direct concern to employers, as payment of this tax is the responsibility of the affected individual, the ACA also imposes a 3.8% tax on “unearned” income of higher income individuals. Employers should at least be aware of this other Medicare-related tax, and may want to alert their higher income employees to consult their tax advisors about it.
Rates and Computation of the Tax
The proposed regulations did not change the rate for payment of the Additional Medicare Tax, nor the threshold amounts of compensation to which it applies, though they did clarify that the rates to be applied are those in effect at the time the employee’s compensation is received. Information about the rates and threshold compensation amounts for the Additional Medicare Tax can be found in the prior Honigman Health Care Reform Alert on October 1, 2012.
Collection of the Tax by the Employer; Payment of the Tax by the Employee
The employer is required to collect the Additional Medicare Tax only to the extent the employer pays wages to the employee in excess of $200,000 in a calendar year, regardless of the employee’s filing status or other income. Employers need only be concerned with how much they are paying the individual employee. For example, if a married couple works for the same employer and each makes $150,000, the employer has no withholding or payment obligations, even though the couple will likely be subject to the Additional Medicare Tax.
- To the extent the employer does not collect the tax from the employee; the employee is still liable to pay the tax.
- If the employer fails to deduct the Additional Medicare Tax, or deducts less than the correct amount of the Additional Medicare Tax, the employer is nevertheless liable for the correct amount of the tax it was required to withhold, until the employee pays the tax. An employer that does not meet its withholding, reporting, deposit and payment obligations for the Additional Medicare Tax may be subject to penalties for these failures, even if it is not liable for the tax itself because the employee has paid it.
- An employee who is paid wages must account for the Additional Medicare Tax on his or her federal income tax return.
- Employees may not ask their employer to withhold the Additional Medicare Tax on compensation below the $200,000 threshold, though an employee may request that the employer withhold additional amounts on Form W-4, if the employee believes his or her combined compensation from all sources might exceed the applicable threshold.
If the employer files a return on which FICA taxes are to be reported and reports less than the correct amount of the Additional Medicare Tax, the employer may only correct the error through an interest-free adjustment if the error is discovered within the same calendar year in which the wages or compensation was paid to the employee, unless (i) the underpayment is attributable to an administrative error, (ii) IRC §3509 applies to determine the amount of the underpayment (i.e., due to employer’s failure to treat the individual as an employee), or (iii) the adjustment is the result of an IRS examination.
The employer may adjust the underpayment by reporting the additional amount due on an adjusted return for the return period in which the wages/compensation are paid, accompanied by a detailed explanation of the amount being reported and any other information required under the adjusted return. The adjusted return must be filed, along with the amount needed to correct the underpayment, by the date on which the filing being corrected is due.
Claiming Credits or Refunds for Overpayments
Any person who overpaid the Additional Medicare Tax may file for a credit or refund of the overpayment, plus any interest due or penalty that may have been paid. Employers, however, cannot claim a refund or credit for an overpayment which the employer has deducted or withheld from an employee’s pay.
An employee may seek a refund or credit if (i) he or she has not received any repayment from the employer and does not authorize the employer to file a claim and receive the refund or credit, (ii) the over collection cannot be corrected by means of an offset against other tax liabilities, and (iii) the employee received pay from multiple employers and did not or could not claim the overpayment as a credit against or a refund of his or her income tax liability.
An employee who seeks a refund or credit for an overpayment must provide a statement that explains the extent, if any, to which the employer has repaid or reimbursed the employee for the overpayment, and the amount, if any, of credit or refund claimed by the employer. The employee should obtain these statements, if possible, from the employer who should include in the statement that it is made in support of a claim against the United States to be filed by the employee for a refund of an employee tax paid by the employer to the IRS.
If an employer collects from an employee and pays to the IRS more than the correct amount of the Additional Medicare Tax and if the employer discovers the error after filing the return and before the end of the period during which it can apply for a credit or refund, the employer shall repay or reimburse the employee the amount of the over collection prior to the expiration of such limitation period.
3.8% Medicare Tax on "Unearned" Net Investment Income
The ACA imposes another Medicare-related tax on higher income individuals that is also scheduled to kick in on January 1, 2013. Though this tax may not be of direct concern to employers, it might be something employers would want employees to know of and to consult their tax advisors or accountants about. Taxpayers with adjustable gross income (AGI) over $200,000 if filing as an individual, or $250,000 for married couples filing jointly, must pay a 3.8% tax on income from interest, dividends, annuities, royalties and rents, which are not derived in the ordinary course of a trade or business, excluding “S” corporation or partnership income. The tax is paid only on the AGI in excess of these threshold amounts. Gross income (and hence AGI) does not include interest on tax-exempt bonds and veterans benefits, among other items. Capital gains from the sale of a primary home in excess of $250,000 for individuals or $500,000 for married couples is subject to this 3.8% tax. Employers that sponsor ESOPs (or a 401(k) plan with an ESOP component) with a dividend-pass-through feature permitted under IRC §404(k) should be aware that if the plan permits and the participant elects to take the dividend in cash, it will be subject to this "unearned income" tax, but not if the dividends are reinvested in additional shares of employer stock.
Employers should ensure that their payroll systems will be able to collect the Additional Medicare Tax on those employees to whom it will apply, properly report such payments both to the IRS and the employee, and be aware of the adjustment procedures for correcting overpayments and underpayments. They should also inform employees who might be subject to either of these additional Medicare-related taxes about them and might also want to advise the potentially affected employees to talk to their accountants or tax advisors about how these new taxes will have to be reported on their federal income tax returns.
If you have any questions about this new Additional Medicare Tax or the Medicare tax on “unearned” income, any other aspect of compliance with the Affordable Care Act or any other employee benefit issues, please contact any of our Employee Benefits attorneys.