The glitch-ridden rollout of Obamacare's health insurance exchanges have been dominating headlines, but for households making more than $200,000, they probably haven't felt any direct impact of the president's signature legislation....yet.
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But by the time 2014 rolls around, they could be shocked to find a potential new penalty for under-payment of taxes.
First, let’s clear up some confusion. There are actually two new taxes associated with this law, but because they happen to take effect at the same income levels- $200,000 (single taxpayer) and $250,000 (married, joint filers)- it’s easy to mix them up.(1) But they are very different in important ways.
The so-called “Medicare surtax” only applies to earned income.
Everyone who receives income from a job (as opposed to investment income) has 1.45% deducted from every paycheck to help cover the cost of Medicare. The new surtax adds another 0.9% to that- but only on earnings of $200,000 (gross) and above.(2) Once your cumulative paychecks reach that amount, your employer will automatically bump up the amount of Medicare tax it is required to withhold from your paycheck.(3)
If you are fortunate enough to fall into this income category, there’s a good chance you don’t cross the $200,000 threshold until, well, about now. That is, in the last quarter of the year. So, in fact, for most of 2013, you haven’t felt the pinch of the new Medicare surtax. Once it kicks in, however, your Medicare tax rate jumps to 2.35% for the rest of the year.
Harris Abrams, a senior analyst with Thomson-Reuters, points out a couple of key things to keep in mind. First, for purposes of the Medicare surtax, “there’s a broader definition of wages.” The amount includes more than the amount in your gross paycheck. Fringe benefits, tips, third-party sick pay, the cost of group-term life insurance and “amounts deferred under a nonqualified deferred compensation plan” also have to be added in. Which means the value of that company-provided parking space could just push you over the $200,000 limit.
In addition, since an employer is only responsible for withholding the appropriate tax from your paychecks and has no idea what your spouse earns, Abrams points out that you could find yourself either over- or under-paying the amount. Here’s how:
Suppose your salary is $230,000. Your spouse doesn’t work outside the home. When your earnings for the year hit $200,000, your company jacks up your Medicare tax to 2.35%.
However, this tax doesn’t apply to married couples unless their joint income hits $250,000 or more.(4) Sure, you’ll the money back when you file your 2013 income tax return, but in the meantime you’re out the cash!
Now let’s look at the opposite situation: You and your spouse work at jobs that pay $150,000a year to make your combined income is $300,000, so you are clearly subject to the surtax. But each of you individually earns less than $200,000. As a result, your respective employers- who have no knowledge of what your spouse earns or how you plan to file your tax return- do not increase the amount of Medicare tax they withhold from your paychecks.
You would probably be shocked to learn that you yourselves should have sent the government the extra money in the form of estimated quarterly tax payments! And, of course, there is a penalty if you don’t. (5)
As Abrams points out, since most Americans receive their income from a job in which their employer withholds taxes on their behalf, they’re not used to submitting additional estimated taxes. They assume that what their employer is taking out of their paychecks is correct.
“But if you and your spouse are earning more than $250,000 a year,” says Abrams, “all of a sudden you are a person who has to make estimated tax payments.”
If you are married and plan to file jointly, he says the key is to keep an eye on your total income. However, you are not required to begin sending Uncle Sam a check until your joint income crosses the $250,000 threshold. For instance, if this occurs between Sept. 1st and Dec. 31, you have until Jan.15 to send Uncle Sam a check.(6)
Next week: The “other” Obamacare tax and when it applies.
1. The thresholds are:
- Single taxpayer or Head of Household: $200,000
- Married, filing joint: $250,000
- Married, filing separately: $125,000
2. According to the tax experts at Thomson-Reuters, “while the employer and employee each pay the 1.45% tax, only the employee is subject to the additional .9% tax.”
3. Unlike the tax you pay toward Social Security, there is no “cap” on the amount of income Medicare tax is levied on.
4. For those who submit their taxes “married filing jointly.”
5. The schedule for paying estimated taxes is:
See IRS Publication 1040-ES for more information: http://www.irs.gov/pub/irs-pdf/f1040es.pdf
6. You do not have to make an estimated payment by January 15, 2014, if you file your 2013 tax return by January 31st and mail the entire balance due with your return.