The Medicare Taxes, They Are a-Changing

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Come gather around, people, wherever you roam; in 2013 Medicare taxes will have grown

As the world counts down to the new year and jokes about the lack of Mayan apocalypse follow-through, the United States government is hard at work hammering out a budget plan for 2013 that will include several tax increases to offset the national deficit. In January of the New Year, two alterations will be made to Medicare taxes; so far very little has been reported about these two changes, but they’ve caused a lot of confusion.

Medicare is funded in part through the collection of payroll taxes from all employed Americans; it’s the main source of income for Part A hospital insurance for recipients. As it currently stands, an employee pays 1.45% of their check into the Medicare fund, and the employer pays another 1.45% to equal 2.9% total. Self-employed people must pay both portions of the tax, but may deduct one half for income tax purposes. Unlike the Social Security tax, which is only applied to earnings up to a certain capped amount, everyone pays into the Medicare fund.

Starting in 2013, certain employees will be subject to a 0.9% increase on their Medicare tax, for a total of 3.8% paid from the payroll. This is to help pay for the increasing number of Americans who are receiving benefits from the Medicare system, as the population ages and the Baby Boomers retire. The tax increase only applies to people earning more than a certain amount of annual income: $200,000 per year for single people and $250,000 per year for married couples with combined earnings. Those who earn less than this threshold will still pay the standard 1.45%.

The other change coming in 2013 is that, for the first time, Medicare tax will be applied to investment income as well as wages—but, again, only for those who earn a certain amount per year. A 3.8% tax will apply to the net investment income of single people whose adjusted gross income (AGI) is above $200,000, and joint incomes over $250,000. This will apply to dividends, rent collection, passive business gains, royalties, and interest on investments. Tax-deferred accounts, like 401(k) retirement funds, will not be subject to the tax.

For most people, this additional tax will not be necessary; it only applies if you make over $200,000 per year in adjusted gross income. Some realtors have voiced concerns, because ‘net investment income’ also includes the gains from the sale of your principal residence. However, it’s important to stress that this will not apply to all real estate transactions. And the tax is only applied to the amounts over the threshold, or the investment income amount—whatever number is smaller. So if your AGI is $238,000, you will be taxed at the new rate for only the $38,000. But if your investment income for the year was $30,000, you would be taxed on that amount instead of the excess AGI.

There have been arguments about whether these two tax increases will stay put in the long run, but they are set to kick-in starting in January 2013. Furthermore, the investment tax portion will take three years to take full effect, so Congress has plenty of time to adjust it as they see fit. Either way, it will be an interesting development in the continuing changes brought on by the Patient Protection and Affordable Care Act, and with any luck it will help the millions of seniors who will need Medicare’s help in the near future.