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Why Do I Pay Medicare Tax?

Just the essentials...

  • Since the Social Security Administration funds Medicare, taxpayers pay for the program through deductions in their earnings

  • As of 2016, taxpayers pay 1.45 percent of their earnings into FICA, which is the Federal Insurance Contributions Act, according to CNN Money

  • Taxpayers and employers began paying Medicare taxes in 1966 at a combined rate of 0.7 percent. Today, taxpayers and employers pay a combined 2.9 percent toward FICA

Why do I pay Medicare tax?

You may often wonder why you must pay taxes for Medicare. Here are a few things you need to know that will help you understand why you pay Medicare taxes.

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How Taxpayers Fund Medicare

Why do I pay Medicare tax?

The Centers for Medicare and Medicaid Services is the government agency that runs the health insurance programs. The center is part of the Department of Health and Human Services. The agencies oversee what are known as Medicare trust funds.

The U.S. Treasury Department holds the two Medicare trust fund accounts which can only be used to fund Medicare.

Payroll taxes, employer taxes and interest earned on the two accounts are used to fund both trust fund accounts. However, the interest earned on the two trust fund accounts comes from the money deposited via Medicare taxes.

Hospital Insurance Trust Fund

The first trust fund account is known as the Hospital Insurance Trust Fund. The funds collected through Medicare Taxes that fund this account pay for Part A hospital insurance benefits, home health care, skilled nursing facilities and hospice care.

This fund also pays for the administration costs associated with the program including the actual collection of Medicare taxes. This trust fund also covers the cost of fighting fraud associated with Medicare.

Supplementary Medical Insurance Trust Fund

Also known as SMI, this fund pays for Part B medical coverage, which covers doctor’s visits and medical supplies and Part D prescription drug coverage.

The money to fund this account comes from premiums that people pay for Parts B and D coverage. Unlike the Hospital Insurance Trust Fund, SMI does not receive funds from payroll taxes.

Self-Employment and Medicare Taxes

Why do I pay Medicare tax?

As of 2016, if you are self-employed, you must pay a 2.9 percent Medicare tax on all of your net earnings. If your net earnings are greater than $200,000 or $250,000 for married couples who file a joint return, you must pay an additional 0.9 percent in Medicare taxes.

According to the IRS, you must pay a self-employment tax if your net earnings from self-employed income were greater than $400.

Additionally, the self-employment tax rules regarding Medicare apply no matter your age and whether or not you currently receive Medicare or social security benefits.

Explaining FICA Taxes

The Federal Insurance Contributions Act, known as FICA, is a law that was passed in 1935 by then President Franklin Delano Roosevelt. FICA was a tax addition to the Social Security Act that was enacted during the 1930s to help the United States recover from the Great Depression.

FICA is a payroll tax deduction from the paychecks of employees and a contribution by employers. FICA taxes are used specifically to fund Medicare and social security benefits. The taxes that employees and employers pay under FICA are mandatory, and the IRS revises the tax rates annually.

Investment Income and Medicare Taxes

Why do I pay Medicare tax?

Enacted on Jan. 1, 2013, the net investment income tax took effect under the Affordable Care Act. If you earned any income that resulted from dividends, interest, capital gains, royalty income or rental income, you may be subject to the net investment income tax.

The law states that you are responsible for a 3.8 percent NIIT tax based on statutory threshold amounts. Here are the current thresholds as of 2016,

  • $250,000 — Married, filing jointly
  • $125,000 — Married, filing separately
  • $200,000 — Single or head of household
  • $250,000 — Qualifying widower with a child

More About Medicare Taxes

Keep in mind that withdrawals from your 401(k), traditional IRAs or 403(b) savings plan may be subject to additional Medicare surtaxes. When you add the withdrawals to any other investment income, it could push you over the thresholds for Medicare surtaxes.

However, any withdrawals from a qualified Roth IRA or a Roth 401(k) does not count toward any earned income or net adjusted income. Trying to determine what qualifies as net investment income and how it affects Medicare taxes is quite tricky, so you should always consult first with a qualified tax advisor.

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