On March 9, 2023, the U.S. Department of the Treasury released the Greenbook (formally known as the General Explanations of the Administration’s Revenue Proposals), to explain the revenue proposals included in Administration’s budget. One proposal in the Administration’s budget would increase the additional Medicare tax rate by 1.2 percentage points for high-income taxpayers.
Self-employment earnings and wages are subject to employment taxes under either the Self-Employment Contributions Act (SECA) or the Federal Insurance Contributions Act (FICA). Both SECA and FICA taxes apply at a rate of 12.4 percent for social security tax on self-employment earnings and wages (capped at $160,200 in 2023) and at a rate of 2.9 percent for Medicare tax on all self-employment earnings and wages (not subject to a cap). In the case of FICA taxes, the employee and employer each pay half of the taxes imposed on wages.
An additional 0.9 percent Medicare tax is imposed on self-employment earnings and wages of high-income taxpayers, above a threshold of $200,000 for single and head of household filers and $250,000 for joint filers. This tax is paid only by the employee in the case of employed workers, i.e., there is no matching share paid by the employer. (To simplify the withholding of the additional Medicare tax, employers are generally required to begin withholding at $200,000 of wages without regard to the employee’s filing status.) This brings the current combined rate of Medicare tax to 3.8 percent for these taxpayers.
The FICA and SECA Medicare taxes flow into the Hospital Insurance Trust Fund (HITF), which finances Medicare Part A. According to current projections from the Medicare trustees, the HITF will be exhausted in 2028. Increasing the additional Medicare tax for high-income taxpayers would extend the life of the trust fund.
To address the funding issue facing Medicare, the Administration’s proposal would increase the additional Medicare tax rate by 1.2 percentage points for taxpayers with more than $400,000 of earnings (presumably, without regarding to filing status). The threshold would be indexed for inflation. The proposal would be effective for taxable years beginning after December 31, 2022.
This would further disconnect the additional Medicare tax from its root as an employment tax and continue the trend toward its becoming a surtax for higher income taxpayers. When combined with current-law tax rates, this would bring the marginal Medicare tax rate up to 5 percent for earnings above the threshold.