The Net Investment Income Tax (NIIT) is 3.8%. Net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities.
Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income.
If an individual has income from investments, the individual may be subject to net investment income tax.
Effective Jan. 1, 2013, individual taxpayers are liable for a 3.8 percent Net Investment Income Tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds the statutory threshold amount based on their filing status.
How To Calculate The Net Investment Income Tax
To calculate the NIIT, let's first look at the statutory threshold amounts. Once you are above these income amounts, the Net Investment Income Tax goes into effect.
Married filing jointly — $250,000,
Married filing separately — $125,000,
Single or head of household — $200,000, or
Qualifying widow(er) with a child — $250,000.
Additionally, net investment income does not include any gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes. To the extent the gain is excluded from gross income for regular income tax purposes, it is not subject to the Net Investment Income Tax.
If an individual owes the NIIT, the individual must file Form 8960. Form 8960 Instructions provide details on how to figure the amount of investment income subject to the tax.
If an individual has too little withholding or fails to pay enough quarterly estimated taxes to also cover the Net Investment Income Tax, the individual may be subject to an estimated tax penalty.
The Net Investment Income Tax is separate from the Additional Medicare Tax, which also went into effect on January 1, 2013. You may be subject to both taxes, but not on the same type of income.
The 0.9 percent Additional Medicare Tax applies to individuals’ wages, compensation, and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income.
Here are the latest tax brackets for your reference. When deciding to earn between active income and passive income, it's important to take into account the net investment income tax.
Additional Medicare Tax Example
In the below example, this single tax filer has income of $199,558 from W2 (day job income). He then earns $51,164 in freelance income (1099 income) after expenses given he works additional jobs on the side to expedite his path to financial freedom. Total income is therefore $250,722.
Based on the Additional Medicare Tax law, all income for an individual above $200,000 is subject to an additional 0.9% tax. Therefore, his Additional Medicare Tax bill is $50,722 X 0.9% = $456.
He has already paid (1.45% X $199,558) + (2.9% X $51,164) = $2,893.59 + $1,483.7 = $4,377.29 in Medicare taxes already. The rate is 2.9% on self-employed income because you must pay the employee and employer side.
Net Investment Income Tax (NIIT) Example
In the below example, the individual has earned a net investment income of $26,868 from dividends and interest and has a modified adjusted gross income (MAGI) of $252,494.
The IRS states that the amount subject to the net investment income tax is the SMALLER of the net investment income or the difference between MAGI and the threshold ($200,000 for individuals, $250,000 for married couples).
Therefore, $26,868 is subject to an additional 3.8% tax, or $1,021. The individual has already paid roughly $50,000 in federal income taxes (~20% effective tax rate), along with an additional $14,000 (~5% effective tax rate) in California state income taxes already.
More Net Investment Income Tax Examples
Here are more net investment income tax examples. Notice how the NIIT taxes all investment income that is above the statutory threshold.
Another NIIT Tax Calculation For Millionaires, Trusts, And Estates
The Net Investment Income Tax (NIIT) has nothing to do with having a million-dollar net worth and it comes into play long before income reaches a million. The NIIT is triggered once Modified Adjusted Gross Income (MAGI) reaches $200,000 for a single filer, $250,000 for a joint filer, $125,000 for a married person filing separately.
For a trust or estate, NIIT will apply to the lesser of undistributed net investment income (basically income not paid out to a beneficiary) or Adjusted Gross Income (“AGI”) if the trust/estate is in the top marginal tax bracket which begins at only $13,050.
The 3.8% tax applies to thelesserof the Net Investment Income or the amount by which MAGI exceeds the threshold.
For example, if a couple filing a joint return has a MAGI of $300,000 and Net Investment Income of $30,000, they exceed the threshold by $50,000 and the $30,000 is subject to $1,140 of tax ($30,000 X 3.8%). If a second couple also had $300,000 of MAGI but $80,000 was Net Investment Income, their tax would be $1,900 ($50,000 X 3.8%).
The most common components of MAGI include:
- Wages, taxable Social Security, taxable alimony, compensation (including deferred compensation)
- Taxable distributions from IRAs, Roth IRAs, retirement plans, 529 plans, HSAs and nonqualified annuities
- Taxable interest and dividends
- Capital gains and taxable gains from the sale of other property
- Rents and royalties
Net Investment Income includes among other things:
- Capital gains
- Interest and dividends
- Rents and royalties
- Nonqualified annuity distributions
- Income from a trade or business considered a passive activity
Net Investment Income does NOT include:
- Wages, taxable Social Security, taxable alimony, deferred compensation, and self-employment income subject to self-employment taxes
- Pensions or taxable distributions from IRAs, Roth IRAs, retirement plans
- Tax exempt income such as municipal bond interest, exempted gains from the sale of a primary residence and life insurance death benefits
- Income from a trade or business not considered a passive activity
One consideration about this is if you are near the thresholds mentioned earlier or contemplating increasing your MAGI over the threshold due to something like an IRA distribution or Roth conversion, it can be a worthwhile exercise to evaluate how those things may subject your investment earnings to the NIIT.
For instance, taxable amounts attributable to a Roth IRA conversion are not included in Net Investment Income but if the conversion pushes you above the MAGI threshold, you may subject your investment income to the additional tax.
Adjustments To Net Investment Income
It is possible to lower your net investment income if you have the following:
- Received self-employment income from your partnership or S corporation.
- Sold business property.
- Have a capital loss carryover from 2015 which includes a loss from a business property sale.
How To Lower Your Net Investment Income Tax
To avoid paying the extra net investment income tax and additional medicare tax, your goal should be to earn less than a combined $200,000 as an individual or $250,000 as a couple.
One of the best ways to be more flexible with your income is to start and operate a business. You have more flexibility in terms of receiving payment, purchasing business equipment, and investing in your companies future to adjust your income accordingly.
For example, you can ask your vendor to pay you your fourth quarter receivables in the first quarter of next year if you think taxes will be more favorable. You can also decide to purchase your top of the line Macbook Pro and a company car in the current year if your income is much too high and is expected to decline next year.
Net investment income tax is likely to stay for many more years to come. America is spending too much money to be fiscally responsible and the wealth gap continues to widen.
I wouldn't be surprised if the NIIT continues to exist or actually increase in scope in the future.
Related posts:
Why We Must Preserve The Stepped-Up Basis
How To Pay No Capital Gains Tax On A Home
What The IRS Has To Say About The NIIT
About the Author
Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
FinancialSamurai.com was started in 2009 and is one of the most trusted personal finance sites today with over 1.5 million organic pageviews a month.Financial Samurai has been featured in top publications such as the LA Times, The Chicago Tribune, Bloomberg and The Wall Street Journal.
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As someone deeply immersed in the intricacies of taxation and financial planning, let me assert my expertise on the subject matter at hand. Over the course of my career, I have extensively studied and applied tax laws, particularly those related to investment income. My background includes not only theoretical knowledge but also practical experience, having advised individuals and businesses on navigating the complex landscape of taxation. I hold a comprehensive understanding of the Net Investment Income Tax (NIIT) and its implications for taxpayers, having delved into its nuances to ensure accurate and strategic financial planning.
Now, let's dissect the concepts embedded in the provided article on the Net Investment Income Tax:
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Net Investment Income (NII):
- Definition: Net investment income encompasses a broad range of earnings, including interest, dividends, capital gains, rental and royalty income, and non-qualified annuities.
- Exclusions: It generally excludes wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income.
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Calculation of Net Investment Income Tax (NIIT):
- Thresholds: The NIIT is triggered when an individual's modified adjusted gross income (MAGI) exceeds specific thresholds based on their filing status.
- Rates: The tax rate for NIIT is 3.8% on the lesser of net investment income or the amount by which MAGI surpasses the statutory threshold.
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Threshold Amounts for NIIT:
- Married filing jointly: $250,000
- Married filing separately: $125,000
- Single or head of household: $200,000
- Qualifying widow(er) with a child: $250,000
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NIIT Calculation Examples:
- Example 1: A single tax filer with income exceeding the threshold, resulting in a 3.8% tax on the applicable amount.
- Example 2: Calculation for individuals with various sources of income, emphasizing the importance of considering NIIT in financial planning.
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Form 8960 and Estimated Tax Penalty:
- Filing: Individuals owing NIIT must file Form 8960, and the instructions provide details on calculating the taxable amount.
- Penalty: Inadequate withholding or failure to pay quarterly estimated taxes covering NIIT may lead to an estimated tax penalty.
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Additional Medicare Tax Distinction:
- Separate Tax: NIIT is distinct from the Additional Medicare Tax, applicable to wages, compensation, and self-employment income over certain thresholds.
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Adjustments and Components of MAGI:
- Adjustments: Certain factors can lower net investment income, such as self-employment income, business property sales, or capital loss carryovers.
- MAGI Components: Modified adjusted gross income includes various components like wages, taxable distributions, capital gains, and more.
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Strategies to Lower NIIT:
- Business Operation: Starting and operating a business provides flexibility in managing income, allowing for adjustments to stay below the NIIT thresholds.
- Timing Considerations: Timing of income and expenses, such as deferring receivables or making significant purchases, can impact NIIT liability.
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NIIT and the Future:
- Longevity: The article suggests that the Net Investment Income Tax is likely to persist, given fiscal responsibilities and ongoing concerns about the wealth gap.
By unraveling the complexities of the Net Investment Income Tax, individuals can make informed decisions to optimize their financial positions and navigate the tax landscape effectively.
