What Is Medicare Tax?

Medicare tax is a mandatory U.S. federal payroll tax under FICA that funds hospital and medical insurance coverage for seniors and people with disabilities.

Hire someone in the U.S., and Medicare tax comes with the territory. It's not optional, it's not negotiable-it's just part of the deal when you've got American employees on payroll.

Here's how it works: Medicare taxes fund the healthcare system that covers Americans when they turn 65 (or if they qualify due to certain disabilities). Specifically, it pays for Medicare Part A-the part that covers hospital stays, hospice care, nursing facilities, and some home health services. Your employees' contributions today keep the system running for everyone who needs it.

The cost gets split down the middle. You withhold Medicare tax from your employees' gross wages, then match that amount from your company funds. It's a 50-50 partnership between employer and employee that happens automatically with every payroll run.

For global companies managing U.S. operations, getting Medicare tax right is vital for payroll compliance. The tax applies regardless of an employee's citizenship status or whether the employer is based domestically or internationally. Getting it right means having systems that automatically calculate, withhold, and remit both employee and employer portions on schedule-because the IRS definitely notices when you don't.

Who pays Medicare tax?

Medicare tax doesn't hit everyone the same way. Who pays what depends on whether you're the employee, the employer, or someone making serious money. Let's break down who's on the hook for what.

Employees pay 1.45% of their gross wages toward Medicare tax with no annual wage cap or limit. This means Medicare tax applies to every dollar an employee earns throughout the year, unlike Social Security tax, which stops at a certain income threshold. The tax covers wages, tips, bonuses, commissions, overtime pay, and certain fringe benefits.

Employers must contribute a matching 1.45% for each employee, bringing the total Medicare tax contribution to 2.9% of an employee's wages. Companies cannot opt out of this matching requirement and must remit both the employee and employer portions to the IRS. This shared responsibility ensures that the Medicare program receives adequate funding while distributing the tax burden between workers and their employers.

High-income employees face an additional 0.9% Medicare tax on wages exceeding specific thresholds. Single filers, heads of household, and qualifying widows pay this extra tax on earnings above $200,000, while married couples filing jointly pay it on income over $250,000. Employers must withhold this additional tax, but are not required to provide a matching contribution, making it solely the employee's responsibility.

Medicare wages

When it comes to Medicare tax, almost every dollar you pay your employees counts as taxable wages. Knowing what's in and what's out keeps you from under-withholding (hello, penalties) or over-withholding (hello, unhappy employees).

• Regular wages and salaries. Base compensation for work performed, whether paid hourly or as an annual salary. This includes standard pay rates for all hours worked during regular business operations.
• Bonuses, overtime, and commissions. Extra earnings beyond base wages, including performance bonuses, sales commissions, and overtime pay for hours worked beyond the standard schedule. These supplemental payments are subject to Medicare tax regardless of when they're paid during the year.
• Tips. Employee-reported tips totaling $20 or more per month must be included in Medicare wages. Employees are responsible for reporting tips to their employers, who then withhold the appropriate Medicare tax.
• Certain taxable fringe benefits. Employer-provided perks that have taxable value, such as personal use of a company car or taxable relocation expenses. Fringe benefits are added to the employee's regular wages for Medicare tax calculation purposes.
• Paid time off and leave. Vacation pay, sick leave, holiday pay, and other forms of paid time off count as Medicare wages. This also includes pay for administrative leave, military leave, bereavement, and jury duty.
• Workers' compensation and short-term disability. Certain wage replacement benefits, like workers' compensation and short-term disability payments, are subject to Medicare tax. These payments maintain the employee's Medicare tax obligations even when not actively working.

How Medicare tax differs from Social Security tax

Medicare tax and Social Security tax are both part of the FICA tax framework, but they serve different purposes and operate under distinct rules. While both taxes split costs equally between employees and employers, they differ significantly in their income caps, rates, and funding objectives.

Depending on the tax bracket, the ROI of employees' contributions varies widely. "While middle-income Americans do not pay any Medicare tax on investment income, high-income people pay a Net Investment Income Tax (NIIT) of 3.8% on investment income that pushes their Adjusted Gross Income (AGI) beyond $250,000 for married couples and beyond $200,000 for others," says Steve Wamhoff, Federal Policy Director.

"While NIIT revenue technically is not directed to Medicare under current law, the general idea is that well-off people will pay a tax with a top rate of 3.8% on their income to help pay for Medicare, whether that income is earned income or investment income," he adds.

Where Medicare tax trips up even experienced employers

Medicare tax seems straightforward until it isn't. Miss one detail-like when those extra withholdings kick in for high earners or which benefits actually count as wages-and you're explaining yourself to the IRS. Here's where most companies stumble and how to stay on your feet.

Not withholding additional medicare tax on time for high earners

Employers must begin withholding the additional 0.9% Medicare tax immediately when an employee's year-to-date wages exceed $200,000, regardless of the employee's filing status or spouse's income. This withholding obligation cannot be waived even if the employee requests it, as the IRS requires employers to withhold based on the $200,000 threshold rather than the employee's actual tax liability.

Misclassifying contractors as employees

Independent contractors paid through Form 1099 are not subject to Medicare tax withholding, making proper worker classification essential for compliance. Misclassifying employees as contractors to avoid Medicare tax obligations can result in significant penalties and back-tax liabilities.

Reporting incorrect wages in box 5 of Form W-2

Box 5 of Form W-2 must accurately reflect all Medicare wages, including bonuses, commissions, taxable fringe benefits, and other compensation subject to Medicare tax. Underreporting these wages can lead to discrepancies between payroll records and tax filings, triggering IRS audits and potential penalties.

Failing to match and remit the employer portion

Employers must contribute a matching 1.45% Medicare tax for each employee, and failing to remit this employer portion can result in penalties and interest charges from the IRS. This matching requirement applies even when employee withholding is correct, making it a separate compliance obligation that cannot be overlooked.

FAQs

Do I need to match the Additional Medicare Tax?

No, employers are not required to match the Additional Medicare Tax of 0.9%. Employers only match the base 1.45% Medicare tax rate, making the additional tax solely the employee's responsibility. The total employer Medicare tax obligation remains at 1.45% regardless of the employee's income level.

Is there a cap on Medicare wages?

No, there is no income limit on Medicare wages, unlike Social Security tax, which has an annual wage base limit. Medicare tax applies to all earned income throughout the year, including wages, bonuses, commissions, and other compensation. This means employees and employers continue paying Medicare tax on every dollar earned, regardless of how much the employee makes annually.

What happens if I under-withhold Medicare tax?

The employer remains liable for any Additional Medicare Tax that was required to be withheld, whether or not it was actually deducted from the employee's wages. If the error is discovered in the same year, employers can make an interest-free adjustment using Form 941-X, but they must still report and pay the correct amount. Employers may face penalties for under-withholding, even if the employee ultimately pays the tax on their individual return.

How do I report Medicare tax to the IRS?

Employers report Medicare tax withholding and wages on Form 941 quarterly employment tax returns throughout the year. At year-end, total Medicare wages and tax withheld must be reported in Box 5 and Box 6 of each employee's Form W-2. For employees subject to Additional Medicare Tax, this information must also be accurately reflected on their W-2 forms to ensure proper tax reporting.

Maintain a compliant payroll with Pebl

Here's what happens when you run payroll through Pebl's Global Work Platform™: Medicare tax calculations become automatic. The right amount gets withheld every time. High earner thresholds get tracked without you lifting a finger. And everything gets reported to the IRS exactly how they want it.

Our EOR services mean you can hire U.S. employees without becoming a Medicare tax expert. Our payroll service platform handles the math, the compliance, and the filing-across all 185+ countries where we operate. Got questions at 2 a.m.? Real humans answer the phone. Need help with a tricky situation? Your dedicated account manager already knows your business.

Stop spending time on tax calculations you shouldn't have to think about. Get in touch, and let's talk about making payroll compliance someone else's problem-someone who actually enjoys this stuff.

Disclaimer: This information does not, and is not intended to, constitute legal or tax advice and is for general informational purposes only. The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. The content in this guide is provided "as is," and no representations are made that the content is error-free.

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