SOME OF MY CLIENTS are political junkies; others don’t follow politics. Either way, they’re mostly aware that the Affordable Care Act, a.k.a. Obamacare, overhauled the rules for medical insurance. But lots of them are unaware that ACA’s overhaul also significantly changed some tax laws—and those changes adversely affected their pocketbooks.
I remind my clients that ACA included a provision that increased Medicare taxes for employees with high incomes. Similarly, it increased self-employment taxes for freelancers with high incomes.
The ACA introduced an additional Medicare tax of 0.9%. Who gets dinged for this surtax? It hits joint filers with wages above $250,000 ($125,000 for married couples filing separate returns) and single filers over $200,000. It also hits individuals with self-employment income above these thresholds. Moreover, once your modified adjusted gross income (same as adjusted gross income for most individuals, except expatriates) reaches these levels, a 3.8% surtax applies to some of your investment income.
Yesterday, Senate Republicans abandoned their latest effort to replace Obamacare. But what if the ACA was repealed and the 0.9% and 3.8% surtaxes went away? While high-income individuals would pay less in income taxes on their earnings and investment income, they’d find that Medicare taxes, unlike Social Security payroll taxes, would still take a piece of every $1 they earn.
ACA left unchanged employees’ existing liability for payroll taxes, officially known as FICA taxes. (FICA is short for Federal Insurance Contribution Act.) Longstanding rules require employers to withhold FICA taxes from amounts paid to their employees as wages, salaries and other forms of compensation. ACA made no change in the requirement that employers, too, must ante up. They have to match the payroll taxes that they subtract from their employees’ compensation.
Different rules, which have been on the books for eons, remain applicable when individuals are their own bosses and operate as sole proprietors, in partnership with others or as independent contractors. While freelancers sidestep FICA taxes, they’re liable for self-employment taxes. Think of them as FICA taxes for the self-employed.
How does a kinder and gentler IRS deal with individuals who are both employees and moonlight as freelancers? The agency will nick them for both FICA and self-employment taxes.
FICA taxes consist of two components with different rates. First, the rate is 6.2% for the Social Security benefits portion, up to a limit of $127,200 for 2017. Once you hit $127,200 in earnings for the year, withholding from your paycheck for Social Security payroll taxes ends. Spoiler alert: The annual cap is indexed, meaning it’s adjusted for inflation and will increase for 2018.
The other FICA rate is 1.45% for the Medicare fund, the federal medical insurance program for the elderly. There’s no ceiling on the amount of wages subject to the 1.45% rate, meaning employees with earnings above $127,200 must pay Medicare taxes on every dollar of their salaries, wages, bonuses, commissions, vacation pay and the like. Workers surrender $14.50 to Medicare taxes for each $1,000 of compensation.
As with FICA taxes, ACA left intact the key rules for self-employment taxes. They’re still imposed at a rate of 15.3% on net earnings (receipts minus expenses). This is twice the 7.65% usually paid by employees, because self-employed persons pay both the employer and employee halves.
Like FICA taxes, self-employment taxes consist of two components with different rates. The rate is 12.4% for the Social Security benefits portion, up to a limit of $127,200 for 2017.
The other self-employment rate is 2.9% for the Medicare fund. There’s no ceiling on the amount of net earnings subject to the 2.9% rate, meaning self-employed persons with earnings above $127,200 pay Medicare taxes on every dollar of their earnings. They forfeit $29 to Medicare taxes for each $1,000 they earn.
Julian Block writes and practices law in Larchmont, NY, and was formerly with the IRS as a special agent (criminal investigator). His previous articles include Moving On and That’ll Cost You 50%. This article is excerpted from Julian Block’s Easy Tax Guide for Writers, Photographers, and Other Freelancers, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.