The Internal Revenue Service recently released final regulations and updated questions and answers to help employers and taxpayers comply with the new 0.9 percent Medicare payroll tax increase on high-income earners that became effective in 2013. Employers are responsible for withholding and reporting the increased payroll tax and may be liable for amounts that are not withheld. Employers should check with their payroll service providers to make sure they are compliant for 2013 and, if not, make any necessary corrections by the last payroll of 2013 to avoid potential liability or penalties.
The Internal Revenue Service (IRS) recently issued final regulations relating to the additional Hospital Insurance (HI) tax on income above threshold amounts (the Additional Medicare Tax), as added by the Affordable Care Act. The IRS also issued updated Questions and Answers for the Additional Medicare Tax. Employers are responsible for withholding and reporting the 0.9 percent Additional Medicare Tax, which became effective in 2013. If an employer fails to withhold the correct amount from wages it pays to an employee, the employer may be liable for the amount not withheld and subject to applicable penalties.
In general, employees and their employers must each pay a Medicare tax, at a rate of 1.45 percent, on the entire amount of the employees’ wages. Effective for employees beginning in 2013, the 0.9 percent Additional Medicare Tax is imposed on individuals for wages in excess of $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately and $200,000 for single taxpayers. Thus, for high-wage earners, the employer portion of the Medicare tax remains at 1.45 percent, but the employee portion can be a total of 2.35 percent of wages in excess of the threshold amounts.
To comply with the Additional Medicare Tax requirement, employers must withhold the 0.9 percent Additional Medicare Tax from wages it pays to an employee in excess of $200,000 in a calendar year, without regard to the employee’s filing status, wages paid by another employer or income from self-employment. Thus, generally the employer need not obtain additional information from the employee regarding the employee’s expected actual liability to withhold amounts due under the Additional Medicare Tax. Note that the withholding obligation exists even if an employee is not ultimately liable for the Additional Medicare Tax (e.g., if an employee’s wages together with those of his or her spouse do not exceed the $250,000 for married taxpayers filing jointly). On the other hand, an employer is not required to withhold the Additional Medicare Tax so long as the employee’s wages do not exceed $200,000, even if the employer has reason to believe the employee will be liable for the Additional Medicare Tax (e.g., if an employee and his or her spouse each earn $150,000). Employers are required to begin withholding Additional Medicare Tax in the pay period in which the employer pays wages in excess of $200,000 to an employee.
Employers that do not deduct and withhold the Additional Medicare Tax are liable for the amount of tax required to be deducted and withheld, i.e., tax applied to wages over $200,000, unless the tax they failed to withhold is paid by the employee. Employers are not relieved of their liability for withholding unless they can show that the tax has been paid by filing Forms 4669 and 4670. Even if not liable for the tax because the employee paid it, employers that do not meet their withholding, deposit, reporting and payment responsibilities for the Additional Medicare Tax may be subject to penalties, unless the failure has a reasonable cause and is not the result of willful neglect.
Employers may not honor an employee’s request to make additional withholding for the Additional Medicare Tax or cease withholding for the Additional Medicare Tax if they are required to withhold. However, an employee may request that the employer withhold an additional amount of income tax on Form W-4 if the employee anticipates liability for the Additional Medicare Tax in excess of what will be withheld.
If an employer underwithholds the Additional Medicare Tax from wages it pays to an employee and discovers the error in the same year it pays the wages, the employer may correct the error by making an interest-free adjustment on the appropriate corrected form (e.g., Form 941-X). Once the employer discovers the error, the employer should deduct the correct amount of Additional Medicare Tax from other wages or other remuneration, if any, it pays to the employee on or before the last day of the calendar year. If the employer overwithholds, the employer should repay or reimburse the amount to the employee prior to the end of the year and make an interest-free adjustment on the appropriate corrected form (e.g., Form 941-X).
In contrast, if an employer underwithholds the Additional Medicare Tax from wages it pays to an employee and discovers the error after the year it pays the wages, the employer cannot correct the error by making an interest-free adjustment. The employer may be liable for the amount it failed to withhold; however, to the extent the employer can show that the employee paid the Additional Medicare Tax, the employer will not be liable for the underwithheld amount but may remain subject to applicable penalties, unless the failure has a reasonable cause and is not the result of willful neglect. If the employer overwithholds, the employer should report the amount of withheld Additional Medicare Tax on the employee’s Form W-2 so that the employee may retain credit to be applied against the taxes shown on the employee’s individual tax return.
2013 Action Item
Employers should check with their payroll service providers to make sure they are complying with their Additional Medicare Tax 2013 obligations as soon as possible. Employers should work with their payroll service providers to correct any errors prior to the last payroll period of 2013 to avoid any potential liability or penalties, as well as to make it easier for employees when they file their 2013 individual tax return.
Please contact your regular McDermott Will & Emery lawyer or one of the authors for further information.