What Does Medicare Tax Mean?

A Medicare tax plays a big role in funding healthcare coverage in the United States. Whether you're employed or running your own business, it's necessary to pay your Medicare taxes.

This tax shows up as a regular deduction as long as you're earning a paycheck. It's not a tax that you can skip paying.

Basically, this tax is part of what's called FICA, which ensures that the Medicare system has the funds that it needs. It applies to employees, employers, and self-employed individuals. 

So, when you see it on your pay stub or while filing taxes, you need to understand what Medicare is about. Let's take a closer look at how this tax works and what it means for your paycheck.

Medicare Tax Meaning

A Medicare tax is a payroll tax that helps fund the healthcare system for older adults and individuals with disabilities. It's part of FICA, which means the Federal Insurance Contributions Act, alongside Social Security tax. Social Security covers individuals’ retirement, survivor benefits, and disability insurance. Medicare tax, on the other hand, funds health care. Medicare is mostly focused on hospital-related services.

This tax goes directly toward Medicare Part A and medical insurance. Part A of Medicare covers inpatient care like hospital stays, skilled nursing facilities, and hospice care. It also includes other types of home health services. Medicare medical insurance directly covers outpatient care and home health care. It also covers services from healthcare providers, including doctors.

Both employers and employees contribute to this fund. If you're self-employed, you're responsible for covering yours. So, every time you see Medicare deduction on your pay stub, it really counts for something. It helps in ensuring access to essential healthcare when it's needed.

What Is the Medicare Tax Rate in 2025?

For 2025, the Medicare tax rate is still at 2.9%, and it applies to all earned income. It is still the same as last year, 2024. If you're employed, this amount is split in half. Therefore, this means that where 1.45% is withheld from your paycheck, your employer pays the other 1.45%. It's a required deduction, and if you don't pay, it could lead to penalties. 

On the other hand, if you're self-employed, you're expected to cover the full 2.9% since you basically work alone.

How Do Medicare Taxes Affect Self-Employment Income?

To explain further how Medicare works for self-employed individuals, read closely. When you work for yourself, this tax is different for you. As mentioned earlier, instead of splitting the costs, you're responsible for paying your entire Medicare tax yourself. This is because the IRS sees you as both the boss and the employee. 

This tax is usually based on your net earnings, which means that you get to subtract your business expenses first. You have to do this before calculating what you owe. It is usually controlled and calculated by SECA, which stands for the Self-Employment Contributions Act.

However, there is a benefit for you. You may be able to deduct half of that amount when filing your taxes, which is 1.45%. This then helps lower your taxable income. Especially if you're self-employed, knowing how this tax works and then planning ahead could help you greatly.

Medicare Surtaxes

So, in order to support the expansion of Medicare, two surtaxes were introduced. These surtaxes were created in 2013 under the Affordable Care Act and are especially for high-income earners. They include the additional Medicare and the net investment income taxes. These two surtaxes support Medicare funding. However, they target different income types:

Additional Medicare Tax

Additional Medicare tax applies to you once your earnings reach a certain level. So, it applies to you if you're a single filer and your earned income is over $200,000. It can be your income, like your salary, wages, or self-employment earnings. Also, it applies to married couples filing jointly when they both earn more than $250,000. Then, they'll owe an extra 0.9% tax on every dollar above this limit.

Giving an example: Let's say you earn $245,000 as an individual. You'll pay the normal 1.45% Medicare tax on the first $200,000, which you already know is required. However, as for the extra $45,000, it gets an added 0.9% tax. This then adds your Medicare tax to a total of 2.35%. 

It's important to note that you don't need to split your additional Medicare with your employer. You have to pay for it yourself.

Net Investment Income Tax

The net investment income tax, on the other hand, is usually referred to as the “unearned income surtax”. This is different from the Additional Medicare, which applies to your current earnings. It has to do with your investment income.

Depending on the various types of investment income you have, this tax imposes an extra 3.8% on each of them. This is also if your Modified Adjusted Gross Income (MAGI) crosses a certain threshold.

So, what then counts as investment income? Well, it includes things like:

• Interest on your savings

• Dividends from stocks

• Capital gains from selling investments or property

• Rental income

• Royalties

• Income from partnerships or annuities

Example: A married couple files jointly. They earn $245,000 from wages and $55,000 from investments. They'll need to calculate the total of each. Therefore, their total MAGI is $300,000. 

Since the normal threshold for net income investment tax for them is $250,000. This means that their total MAGI is $50,000 more than the threshold. They'll then pay 3.8% on that $50,000. Therefore, the total for their net income investment tax is $1,900. Also, for these taxes, you're not going to split this 3.8% with your employer.

There are, however, ways that you could remove or reduce the 3.8% on your net income investment tax. You can either do this by reducing your MAGI or by increasing your total investment. Here's how you can do that:

• You start by moving your investments into accounts that the surtax can't reach. You can move them to accounts, such as traditional and Roth IRAs, employer-sponsored 401(k)s, and HSAs. These accounts allow your investments to grow without being taxed each year. Your earnings inside these accounts are not usually counted as net investment income.

• You can also shift your investments to municipal bonds. Interest from government-issued bonds usually isn't taxed by the federal government. Therefore, it is also excluded from your net investment income calculation.

• Lastly, you can also time your capital gains. You can do this by spreading the sale of your capital gains over several tax years. You can also sell your investments when your MAGI is lower to reduce your investment tax.

Incomes Exempt From Medicare Tax

Some incomes are not subject to Medicare tax. Some of them include contributions you make toward health savings accounts and medical, dental, or vision insurance premiums. It also includes flexible spending accounts for dependent care.

These benefits help you save on taxes and cover your basic costs. However, not every pretax deduction qualifies for Medicare tax exemption. Deductions for life insurance and retirement accounts, such as 401(k) plans, can reduce other taxes. But they are still taxable under Medicare.

In Summary

Understanding how Medicare tax works is extremely important. When you're able to get it, it can make a big difference in how you manage your income. When it is time to file your taxes, make sure you review your pay stubs. This helps you know exactly how much is being withheld for Medicare. In cases where you're confused about anything, you can talk to a tax advisor who can help you understand. You can also stay on track with your earnings.

With our pay stub generator, it's easy to understand your earnings, including your Medicare taxes. Our tool creates pay stubs that allow control of your earnings and all of your deductions. Try using our pay stub generator today!