How withholding works.

Payroll taxes for Social Security and Medicare benefits are collected under the authority of the Federal Insurance Contributions Act (FICA), and are often referred to as the FICA tax. For 2017, Social Security (Old-Age, Survivors, and Disability Insurance, or OASDI) withholding is 6.2% on a wage base limit of $127,200. That means a maximum of $7,886 per employee will be withheld in 2017 ($127,200 × 0.062).

Medicare tax on investment income.

Health care reform legislation also imposed an additional 3.8% surtax on net investment income for taxpayers with an AGI over $200,000 (for single filers) or $250,000 (for married couples filing jointly). The tax is based on your total net investment income, or on the amount by which your income exceeds the AGI thresholds—whichever is less. The surtax applies only to the amount of investment income or AGI that exceeds the thresholds.

When preparing for the Medicare tax, it’s helpful to understand what’s considered unearned investment income under the law.

Unearned income for purposes of the surtax includes:

  • Net rental income
  • Dividends
  • Taxable interest
  • Net capital gains from the sale of investments (including second homes and rental properties)
  • Royalties
  • Passive income from investments in which you’re not an active participant (such as a partnership, for example)
  • The taxable portion of nonqualified annuity payments

For purposes of the surtax, unearned investment income does not include:

  • Tax-exempt interest from municipal bonds or funds
  • Withdrawals from a retirement plan such as a traditional IRA, Roth IRA, or 401(k)
  • Payouts from traditional defined benefit pension plans or annuities that are part of retirement plans
  • Life insurance proceeds
  • Veterans’ benefits
  • Social Security benefits
  • Income from businesses in which you’re an active participant, such as S corporations or partnerships

Figuring out your modified AGI and determining the amount of your unearned investment income can be a bit complex. It’s a good idea to consult with your tax advisor if you think you may be subject to the net investment income surtax.

Income taxes and your Social Security benefits.

If your income exceeds certain thresholds set by the IRS, you may have to pay federal income tax on a portion of your Social Security benefits.

If you are single, file a federal tax return as an “individual,” and your combined income* is:
Between $25,000 and $34,000 you may have to pay income tax on up to 50% of your benefits.
More than $34,000 up to 85% of your benefits may be taxable.
File a joint return, and you and your spouse have a combined income* that is:
Between $32,000 and $44,000 you may have to pay income tax on up to 50% of your benefits.
More than $44,000 up to 85% of your benefits may be taxable.

If you have to pay taxes on your Social Security benefits, you can make quarterly estimated tax payments to the IRS or choose to have federal taxes withheld from your benefits. Requests to have federal taxes withheld from your benefits can be made using Form W-4V, Voluntary Withholding Request.

*Your “combined income” is calculated as follows:

Your adjusted gross income
+ Nontaxable interest
+ Half of your Social Security benefits
= Your combined income

Additional resources.

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Clients of independent investment advisors: You may also contact your advisor or call Schwab Alliance at 800-515-2157.