Guidance Issued on Additional Medicare Tax

The IRS issued proposed regulations concerning the 0.9% Medicare surtax, which takes effect next year (REG-130074-11). The proposed regulations contain guidance for employers and individuals on the implementation of the tax, including the requirement to file a return reporting the tax, the process for employers to make adjustments of underpayments and overpayments of the tax, and the processes for employers and employees to file claims for refund for an overpayment of the tax. The IRS intends to finalize the rules in 2013; however, taxpayers may rely on the proposed rules now.

The additional Medicare tax was enacted as part of 2010’s health care reform legislation. It imposes an additional 0.9% tax on FICA wages, Railroad Retirement Tax Act compensation, or self-employment income that exceed certain threshold amounts: $250,000 for married taxpayers filing jointly; $125,000 for married taxpayers filing separately; and $200,000 for other taxpayers. The additional Medicare tax is not imposed until wages exceed those thresholds, and there is no corresponding amount owed by the employer. The tax is effective for wages received in any tax year starting after Dec. 31, 2012.

Withholding

The proposed regulations provide that an employer must withhold additional Medicare tax from an employee’s wages only to the extent that the wages the employee receives from the employer exceed $200,000 in a calendar year. In determining whether wages exceed $200,000, the employer does not take into account the employee’s filing status or other wages or compensation that may affect the employee’s liability for the tax.

An employee may not request that the employer deduct and withhold additional Medicare tax on wages of $200,000 or less. However, an employee who anticipates that he or she will be liable for additional Medicare tax—for example, if household wages will exceed the married filing jointly threshold—may request that the employer deduct and withhold an additional amount of income tax on Form W-4, Employee’s Withholding Allowance Certificate.

Reporting and payment obligation

An employee is liable for additional Medicare tax on wages or compensation to the extent that the tax is not withheld by the employee’s employer. Individuals must report the tax on Form 1040, U.S. Individual Income Tax Return, and will claim on the Form 1040 credit for any tax withheld or pay any tax due that was not previously withheld or paid as an estimated tax.

The proposed regulations illustrate how the threshold amounts for self-employed individuals are reduced (but not below zero) by the amount of any FICA wages taken into account in determining the individual’s additional Medicare tax liability. However, Railroad Retirement Act compensation does not similarly reduce the thresholds.

Interest-free adjustments

Under the proposed regulations, adjustments for underpayments of the additional Medicare tax can only be made if the error is ascertained in the same year the wages or compensation was paid, unless the underpayment is attributable to an administrative error; Sec. 3509 applies to determine the amount of the underpayment, due to the employer’s failure to treat the individual as an employee; or the adjustment is the result of an IRS examination.

An adjustment of overpaid additional Medicare tax can be made only if the employer ascertains the error in the year the wages or compensation was paid and repays or reimburses the employee the amount of the overcollection before the end of the calendar year.

Claims for refund

Employers can claim refunds of overpaid additional Medicare tax only if the employer did not deduct or withhold the overpaid additional Medicare tax from the employee’s wages or compensation.

Employees claim a refund or credit of overpaid additional Medicare tax by taking the overpayment into account in claiming a credit against, or refund of, tax on an individual tax return for the year in which the overpayment was made, or for a tax year for which a tax return has been filed, by filing Form 1040X, Amended U.S. Individual Income Tax Return. This process is in lieu of filing a claim for refund for overpaid additional Medicare tax on Form 843, Claim for Refund and Request for Abatement. Employees may only claim a refund of additional Medicare tax if they have not received repayment or reimbursement from their employer in the context of an interest-free adjustment.

The rules in the proposed regulations will be effective when they are published as final regulations in the Federal Register, which the IRS says it intends to do in 2013. However, taxpayers may rely on the proposed rules now. The IRS has scheduled a public hearing on the proposed regulations. It will be held April 4 in Washington.