United States: Employer Errors In Dealing With Additional Medicare Tax

The IRS has modified two of its "frequently asked questions" (FAQs) relating to the additional 0.9 percent "high-earner" Medicare tax that is required to be withheld starting this year. The modifications address how to deal with withholding errors, and prescribe rules depending upon when the errors are discovered.

Individual taxpayers who receive wages in excess of $200,000 ($250,000 if married filing jointly; $125,000 if married filing separately) are required to pay an additional 0.9 percent Medicare tax on those excess wages. This tax is in addition to the regular Medicare tax of 1.45 percent on all wages received by the employee, but is imposed only on the employee. The employers' Medicare tax rate is unchanged at 1.45 percent (and the OASDI portion of FICA is still 6.2 percent for each of the employer and employee, on wages up to the taxable wage base for the calendar year).

Employers are required to begin withholding the additional 0.9 percent once an employee's wages pass $200,000, even if the employee may not ultimately be liable for the additional tax (e.g., a married employee whose income is $240,000 on a joint return). In such a case, any excess Medicare tax that is withheld is credited against the employee's total tax liability shown on his or her income tax return, similar to "excess" FICA that may be withheld from an employee who works more than one job during a calendar year.

On the other hand, there may be additional Medicare tax owed by an employee even if there was none required to be withheld, such as where a married couple each earn less than $200,000 but together earn more than $250,000. In the case of a self-employed individual, the additional Medicare tax also applies to self-employment income in excess of the same thresholds, but reduced by the amount of wages (if any) that the individual earns that are subject to Medicare tax on wages.

To the extent that it is required to be, but is not, withheld, the additional Medicare tax has to be included by the employee when determining estimated tax payments. In addition, an employer is liable for any additional Medicare tax that is required to be withheld, whether or not it deducts the tax from wages that it pays to an employee. If an employer fails to withhold the correct amount of additional Medicare tax and discovers the error in the year in which it should have withheld the tax, the employer should make an interest-free adjustment on the applicable corrected employment tax return (e.g., Form 941-X), and the missed amount of additional Medicare tax should be deducted from other wages or remuneration that it pays to the employee on or before the last day of that year. However, whether or not the employer is able to deduct the correct amount of additional Medicare tax from the employee's other wages or remuneration, the employer must report and pay the correct amount of additional Medicare tax. If the employer pays additional Medicare tax without having deducted it from the employee's wages or other remuneration, the employee's obligation to repay the employer is strictly a matter to be settled between them.

If an employer mistakenly withholds too much additional Medicare tax and discovers that error in the same year, the employer may correct that error as well by making an interest-free adjustment on the applicable corrected return (e.g., Form 941-X). However, the employer must first repay or reimburse the employee for the overwithholding before the end of the calendar year; if the employee is not repaid or reimbursed before the end of the year, the overwithholding cannot be corrected with an interest-free adjustment.

If an employer fails to withhold the correct amount of additional Medicare tax (that is, it either withholds too much or not enough, or fails to withhold the tax altogether) and only discovers the error after the end of the year, no interest-free adjustment is allowed. In any such case, the employer is required to report the actual amount of additional Medicare tax withheld (if any) on the employee's Form W-2 for the year of withholding. The employee then computes the proper amount of additional Medicare tax as part of the tax liability on his or her individual income tax return, taking credit for any amount that the employer did withhold (including any excess withholding). To the extent the employer can show that the employee paid the additional Medicare tax on a Form 1040, it will not be liable for an amount that it failed to withhold. However, the employer remains subject to any applicable penalties.

While the employer cannot correct over- or under-withholding by making an interest-free adjustment in a later year, the employer should still correct the amount of any incorrectly reported wages on the appropriate corrected return (i.e., Forms 941-X, 943-X, 944-X, or CT-1X).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.