Medicare is a federal health insurance program providing care to a whopping 67.7 million people. All employees, employers, and self-employed business owners share in funding Medicare through the Medicare Tax. But what if you are a new business owner or an established one seeking a refresher on what this means for your company? This guide offers an in-depth look at what makes up the Medicare tax, how the calculations come together, and how to be sure you’re keeping up with the legal requirements.
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What is Medicare tax?
Medicare tax, also known as the hospital insurance tax, is a payroll tax mandated by federal law to fund the Medicare program, which provides health insurance to individuals aged 65 and over and certain younger individuals with disabilities.
Employers are responsible for withholding Medicare tax from employee wages through payroll deductions and contributing a matching amount. Self-employed individuals are required to pay the combined employer and employee tax amount. In 2024, nearly $407 billion was collected from the Medicare tax.
The purpose of Medicare tax
Simply put, Medicare tax supports the Medicare Trust Funds, a collection of four funds that finance the Medicare health insurance program for the elderly, those with disabilities, and people with qualifying health conditions. Contributions help pay for hospital insurance, critical care, and medical services under the Medicare program.
To learn more, we spoke with David Kindness, a financial writer, certified public accountant, and expert contributor to OnPay.
“Since its creation in 1965 by Lyndon B. Johnson, Medicare – and the Medicare tax – has become an integral component of the United States healthcare system. Without it, millions of individuals would go without medical care, or be forced to pay significantly more for their care.”
— David Kindness, Certified Public Accountant (CPA)
Nearly every American worker and business must pay Medicare taxes due to the Federal Insurance Contributions Act (FICA), which is a federal law that mandates the collection of taxes to fund Social Security and Medicare. It’s one of the reasons why the government keeps a close eye on contributions. Again, we caught up with David.
“To intentionally evade paying these taxes is illegal, and underpaying them, even if done so unintentionally, can result in both steep penalties and interest, as well as trouble with the Internal Revenue Service (IRS) – and no one wants that.”
The takeaway is that you’re legally obligated to pay these taxes if you earn income in the United States, whether you’re an employee, an independent contractor, or both. The moral of the story: Uncle Sam always collects his portion.
However, certain circumstances may exempt some income earners from paying these taxes, which we’ll discuss below.
Can I opt out of paying Medicare tax?
The short answer is no, you cannot opt out of paying the Medicare tax (or the Social Security tax), Paying both the Medicare tax and the Social Security tax is mandatory for workers in the United States. The federal government requires that you pay these taxes because of the Federal Insurance Contributions Act (FICA), which is a federal law.
However, David says certain circumstances may exempt a small number of taxpayers from paying these taxes.
“If a taxpayer has little or no earned income (income they worked for), then they will most likely not be required to pay Medicare taxes. This usually happens either when someone is too young or too old to maintain a job, or if someone makes money from investments rather than from working. For example, investing their money in stocks, bonds, mutual funds, REITS, or other investment vehicles, and receive interest, dividends, and capital gains on their investments.”
— David Kindness, CPA and OnPay subject matter expert
Investment income is taxed differently than earned income, and FICA taxes are not charged on this income.
Components of the Medicare tax
There are two components to Medicare taxes:
- Standard Medicare tax rate: The base rate for Medicare tax is 1.45% of an employee’s wages. Employers must match this 1.45% amount for a total of 2.9% contributed per employee. Self-employed individuals pay the full 2.9% of their self-employment income.
- Additional Medicare tax: Individual employees earning over $200,000 per year, or $250,000 for married couples filing jointly, or $125,000 for married tax filers filing separately are subject to an additional Medicare tax of 0.9%. While employers are responsible for withholding this amount from high earners, they are not required to match it.
Moving on, let’s examine a few examples to learn more about how the numbers come together.
How to calculate Medicare taxes
Calculating Medicare taxes involves applying the standard tax rate and, if applicable, the additional tax rate. Here’s how to calculate payroll taxes for Medicare and below we walk through a few different scenarios.
Example: an employee earning $50,000 a year
- An employee earning $50,000 per year will have a 1.45% tax withheld by the employer, amounting to $725. The employer also contributes 1.45%, or $725, for a total Medicare tax of $1,450, or 2.9% of an employee’s wages.
- Here is a simple way to look at the Medicare tax for an employee making $50,000: $725 (1.45% from employee) + $725 (1.45% from employer) = $1,450 total contribution (2.9% of employee wages).
Example: a single-filer employee earning $250,000 a year
- For higher earners exceeding $200,000 in wages (or $250,000 for joint filers), the employer also withholds the additional Medicare tax only from the portion of earnings over the $200,000 threshold.
- For example, first, there’s the standard Medicare tax. Both parties (employee and employer) would contribute $3,625 ($250,000 x 1.45%), equaling a total of $7,250 in standard Medicare tax. The employee must also pay 0.9% on wages over $200,000, which in this case is $50,000, which equals an additional $450 in tax. The overall Medicare tax on a $250,000 salary is $7,700.
- Here is a simple way to look at the Medicare tax for an employee making $250,000: $3,625 (1.45% from employee) + $3,625 (1.45% from employer) + $450 (0.9% from employee on wages over $200,000) = $7,700.
Example: self-employed individuals
- A self-employed individual earning $50,000 is responsible for paying the full 2.9%, or $1,450.
- A self-employed individual earning $250,000 is responsible for paying the full $7,700, or 2.9% on the first $200,000 plus 0.9% on the amount over $200k.
Once more we caught up with David to understand some of the burning questions people have on this topic.
Can I opt out of Medicare?
As we discussed above, it’s difficult to avoid paying Medicare taxes, and the same is true for taking Medicare benefits. Medicare benefits are broken down into four parts: Medicare Part A, B, C, and D, and each type impacts beneficiaries differently. Let’s take a look at the differences:
- Medicare Part A (Hospital Insurance): If you’ve worked and paid Medicare taxes for at least 10 years of your life, you’ll generally qualify for Medicare Part A when you reach age 65. Part A is generally premium-free, making it incredibly low-cost. However, you can’t refuse this coverage without also giving up your Social Security (or Railroad Retirement Board) benefits, and you’d also have to repay any Medicare benefits you’d already received.
- Medicare Part B (Medical Insurance): Medicare Part B is electable – you can choose to enroll in it or decline it altogether. Part B covers doctors visits, outpatient care, and other medical services. You can decline Part B, but if you choose to enroll in it later on, you may be charged a late enrollment penalty.
- Medicare Part C (Medicare Advantage Plans): This involves private health plans that contract with Medicare to provide all of your Part A and Part B benefits. Part C is electable and there is no penalty for refusing it.
- Medicare Part D (Prescription Drug Coverage): Part D covers the cost of prescription drugs, and is offered by private insurance companies that have contracts with Medicare. Part D is electable and there is no penalty for refusing it.
“As we can see, the cost of opting out of Medicare Part A is significant – millions of Americans rely on Social Security to pay their bills each month. Giving this up is impossible for many. Medicare Part B can be declined at no cost, but keep in mind that a late enrollment penalty may apply if you choose to enroll later on.”
— David Kindness, CPA and OnPay subject matter expert
Next, let’s move onto another question that many people ask about these taxes. “For most individuals, the obligation to pay Medicare taxes will continue for the entirety of their working lives,” says David. However, there are two scenarios that may reduce or eliminate taxpayers’ Medicare tax liability:
- Retirement: The most obvious of these is retirement. When you stop earning an income, you stop paying Medicare (and Social Security) taxes. However, keep in mind that if you keep earning an income from self-employment after you retire from your job, you’ll still be liable for Medicare taxes.
- Investment income: As mentioned above, if you stop earning income at a job or as a self-employed individual, and start earning your income from investments alone, you will no longer be liable for paying the Medicare tax because only earned income is subject to this tax.
The most common situation where someone stops paying the Medicare tax is when they retire from working as an employee or self-employed individual, and stop earning income. Generally, these individuals also only receive income from their investments in the form of interest, dividends, and capital gains, which are exempt from Medicare taxes.
Payroll tax calculations
Getting your payroll tax calculations right can go a long way toward preventing unwanted attention from Uncle Sam. To put this in perspective, in 2023, the IRS recovered around $10 billion in late fees, penalties, and back payments due to payroll mistakes.
How to accurately calculate payroll taxes
Here’s how employers can calculate payroll taxes accurately.
- Understand wage base limits: Unlike Social Security taxes, Medicare tax has no wage base limit, meaning the 1.45% rate applies to all taxable wages without a cap, and the 0.9% additional medicare tax on high earners also has no upper limit. Self-employed individuals must remember to pay both the employee and employer portion of the Medicare tax.
- Invest in tools: Automated online payroll systems such as OnPay can help simplify calculations by making sure that employees, employers, and self-employed business owners pay the correct rates based on wage thresholds.
- Perform regular audits: Periodic checks of payroll records help to spot discrepancies, strengthen internal controls, and help to make sure that you’re keeping up with compliance. You can also add a regular payroll audit to your to-do list or ask for help from your bookkeeper or CPA.
Eligibility for Medicare and tax obligations
Medicare eligibility is based on specific criteria:
- People age 65 or older
- People under 65 who have a disability, End-Stage Renal Disease, or ALS (also called Lou Gehrig’s disease)
Medicare has four parts: Hospital Insurance (Part A), Medicare Insurance (Part B), Medicare Advantage Plans (Part C), and Drug Coverage (Part D). Eligibility and premiums depend on several factors, but for most people, Part A is free.
All US employees, except for certain nonresident alien groups, must pay Medicare taxes, even if they are not US citizens.
Make sure to stay compliant with Medicare tax regulations
Meeting Medicare tax requirements is more than just moving money from “point A to point B” as it makes such a significant impact in funding a federal program so many people count on. That’s why it’s so important for employers to accurately calculate, withhold, and submit these taxes to the IRS. Doing this manually can be a heavy lift, so if you need help calculating payroll taxes, OnPay’s award-winning payroll software can make this hassle-free.
Best of luck as you keep moving your organization forward, and our team is ready to help — or answer any questions!
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.