Medicare Taxes, IRMAA, and You

How the American Health Care Act Cuts Medicare Taxes

Supreme Court columns with American flag and US Capitol
istockphoto

People over 65 years old and those with certain disabilities rely on Medicare for their healthcare needs. Most of them paid for the privilege by way of taxes. Read on to understand what taxes are used to fund Medicare, who pays for them, and how they work. More importantly, how would the American Health Care Act change how much you pay out of pocket in Medicare taxes?

How Medicare Funding Works

Medicare is broken down into four parts: Part A hospital insurance, Part B medical insurance, Part C Medicare Advantage coverage, and Part D prescription drug coverage.

Taxes paid to the federal government are put towards the Medicare Trust Fund, which is used to fund Part A coverage only. This includes not only your inpatient hospital care but other services like hospice, skilled nursing facility care, and home health care.

Monthly premiums may also be used to fund Medicare Part A, but generally speaking, few people pay them. This is because premiums are free to anyone who has worked 40 or more quarters in Medicare-qualifying employment, meaning they already paid their fair share of taxes. People who worked less than 40 quarters will pay monthly premiums that are added to the Medicare Trust Fund.

For 2017, people who worked between 30 and 39 quarters in Medicare-taxed employment will pay $227 per month in Part A premiums, while those working less than 30 quarters will pay $413.

Medicare Parts B through D are funded primarily through your monthly premiums.

Unlike Part A, everyone pays a monthly premium for these services. Some of you, however, will pay a bit more based on your income level.

Income-Related Monthly Adjustment Amount (IRMAA)

The Income-Related Monthly Adjustment Amount (IRMAA) is not a tax per se, but it is an added fee you will pay for Parts B and/or D if your income is above a certain level.

The funds go directly to Medicare, not to the private insurance company that sponsors your Medicare plan, and will be based on your modified adjusted gross income or MAGI.

Your gross income is based on your wages (including tips), income from businesses/investments, interest earned, unemployment benefits, and alimony. It is "adjusted" based on any IRS-approved deductions you can then make, e.g., expenses ranging from IRA contributions to student loan interest. The value is "modified" by adding any tax-exempt interest income you have. The federal government then uses MAGI to determine how much you will pay for taxes, and if you are eligible for Medicaid, tax credits, or other federal-sponsored subsidies.

For the purposes of Medicare, MAGI is used to determine if you will pay IRMAA. People filing $85,000 or less on their tax returns, or married couples filing jointly for $170,000 or less, will not pay IRMAA. If you earn above these levels, you will be charged extra.

For 2017, Medicare Part B IRMAA are $53.30, $133.90, $214.30, and $294.60 per month as you go into higher income brackets. For Medicare Part D, IRMAA is $13.30, $34.20, $55.20, and $76.20 per month.

The IRMAA-eligible income brackets start at $85,001- $107,000 for single filers and $170,001 to $214,000 for joint filers.

They top off at $214,000 and $428,000 for single and joint filers respectively.

For the record, Part B IRMAA was initiated by Congressional legislation in 2007, and Part D IRMAA in 2011 as part of the Affordable Care Act, aka Obamacare.

The Medicare Tax

The Medicare Tax originated in 1966 and is applied to your earned income, minus any deductions for employer-sponsored health premium or for other pre-tax deductions. It does not apply to capital gains and other investment income. The proceeds from this tax go directly towards the Medicare Trust Fund.

How much you pay in taxes depends on your employment status.

People who are employed will pay half the required Medicare tax, and this amount will be deducted directly from your paycheck. This is because your employer pays the difference.

Those who are self-employed are required to pay the full Medicare Tax amount, both employee and employer contributions. It is expected that the self-employed pay their taxes quarterly to the government or otherwise face late penalties.

In 1966, the Medicare Tax began at a modest rate of 0.7 percent. Today, the payroll tax is increased to 2.9 percent.

If you are employed, you will pay only 1.45 percent and your employer pays a 1.45 percent matched contribution. If you are self-employed, you are responsible for the full 2.9 percent rate.

The Additional Medicare Tax

If you earn more, you are going to pay more.

The Affordable Care Act added an Additional Medicare Tax that was first applied in January 2013. It affected those who earned above the following MAGI levels.

  • Single or head of household - $200,000
  • Married filing jointly - $250,000
  • Married filing separately - $125,000
  • Qualifying widow(er) with dependent child - $200,000

Any income above these amounts would be charged an additional 0.9 percent in Medicare taxes. Unlike the traditional Medicare Tax, this tax is paid entirely by the employee. The employer makes no contributions.

For example, a single employed person earning $250,000 per year would pay 1.45 percent in Medicare taxes for the first $200,000 but a 2.35 percent tax (1.45 percent + 0.9 percent) on the remaining $50,000. The employer would continue paying 1.45 percent for the full range of income.

If you are self-employed, you would pay the standard 2.9 percent Medicare tax rate on any income below the threshold amount and an Additional Medicare Tax of 3.8 percent (2.9 percent + 0.9 percent) on any income over the threshold.

Net Investment Income Tax

Another tax added by the Affordable Care Act is the Net Investment Income Tax (NIIT), also known as the Unearned Income Medicare Contribution Surtax. It applies to people who earn above the following MAGI levels and who have investment income:

  • Single or head of household - $200,000
  • Married filing jointly - $250,000
  • Married filing separately - $125,000
  • Qualifying widow(er) with dependent child - $250,000

Essentially, it is a 3.8 percent Medicare tax applied to your net investment income. This may include certain annuities, capital gains, dividends, rental income, and royalties. NIIT specifically does not apply to wages, self-employment income, alimony, pensions, retirement account distributions, Social Security benefits, tax-exempt interest, or unemployment benefits.

The Additional Medicare Tax is distinct from NIIT because it does not apply to net investment income. However, the IRS does state that it is possible you could be faced with both taxes.

You will be taxed for NIIT based on the lesser amount of your net investment income or the amount by which you exceed the MAGI threshold.

How the American Health Care Act Changes Medicare Taxation

Earlier versions of the American Health Care Act (AHCA), now referred to as the Better Care Reconciliation Act (BCRA), aimed to decrease Medicare taxes by eliminating the Additional Medicare Tax and the Net Investment Income Tax. This raised considerable debate over tax breaks for the wealthy.

The Joint Committee on Taxation claims that repealing the Additional Medicare Tax would decrease federal revenues by $117 billion by 2026. With fewer dollars coming into the Medicare Trust Fund, Medicare would deplete its funding by 2025, three years earlier than expected. This is in direct contrast to the Affordable Care Act which actually extended the solvency of Medicare by 11 years.

Financial reports also show that the majority of Americans are unlikely to benefit from this tax overhaul. In fact, millionaires would receive 79 percent of all the tax cuts. By 2025, millionaires would benefit with an average savings of $50,000 per year, multi-millionaires up to $250,000 per year, and the top 400 earners as much as $7 million per year.

People earning less than $200,000 or married couples less than $250,000 would see no change in their taxation.

In fact, not only would low- and middle-income citizens continue to be taxed at the same rate, but many millionaires would actually pay a lower tax rate than Americans earning less than they do. This is because the wealthy earn a large proportion of their dollars through non-taxable income. Since that part of the income would no longer be taxed by NIIT, they have the potential to reap large rewards.

With a repeal of NIIT, expect the wealthiest Americans to do some creative accounting. The wealthiest Americans are likely to shelter their funds by shifting their income to non-taxable sources. A middle-income individual would continue to face a Medicare tax rate of 2.9 percent, while the multi-millionaire could manipulate the numbers to pay no taxes on parts of their income.

As initially presented, the American Health Care Act/Better Care Reconciliation Act would unfairly burden low- and middle-income Americans while inadequately funding a healthcare program that is needed for our oldest and sickest citizens. On July 13, 2017, in response to public outcry, the GOP released a new version of the Better Care Reconciliation Act that deferred eliminating these taxes. 

A Word From Verywell

Funding a federal healthcare program comes at a price—ideally one that is fair to all its constituents. Medicare taxes have been in effect since 1966 with additional taxes added over the years. The goal was to increase funding for Medicare and to allow Americans to contribute according to their means.

Sources:

HI 01101.020 IRMAA Sliding Scale Tables. Social Security Administration website. https://secure.ssa.gov/poms.nsf/lnx/0601101020. Updated November 23, 2016.

Huang C, Marr C, Horton E. House GOP Health Plan Eliminates Two Medicare Taxes, Giving Very Large Tax Cuts to the Wealthy. Center on Budget and Policy Priorities. http://www.cbpp.org/research/federal-tax/house-gop-health-plan-eliminates-two-medicare-taxes-giving-very-large-tax-cuts. Updated March 20, 2017.

Medicare Premiums: Rules For Higher-Income Beneficiaries. Social Security Administration website. https://www.ssa.gov/pubs/EN-05-10536.pdf. Published January 2017.

Questions and Answers for the Additional Medicare Tax. IRS website. https://www.irs.gov/businesses/small-businesses-self-employed/questions-and-answers-for-the-additional-medicare-tax. Updated December 6, 2016.

Questions and Answers on the Net Investment Income Tax. IRS website. https://www.irs.gov/uac/newsroom/net-investment-income-tax-faqs. Updated October 13, 2016.

Continue Reading