Basics of the Net Investment Income Tax
10/28/2016 | Articles & Alerts
As the end of the year approaches, many taxpayers will soon be feeling the bite of the Net Investment Income Tax (which is not required to be withheld from wages and is subject to estimated tax provisions). What it is, who it impacts and how it is computed are summarized below.
What is the Net Investment Income Tax (NIIT)?
The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code (IRC). The NIIT applies at a rate of 3.8 percent to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. The NIIT affects income tax returns of individuals, estates and trusts for their first tax year beginning on (or after) Jan. 1, 2013.
Who Owes the Net Investment Income Tax
What individuals are subject to the Net Investment Income Tax?
Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds (which are not indexed for inflation):
Married filing jointly: $250,000
Married filing separately: $125,000
What Estates and Trusts are subject to the Net Investment Income Tax?
Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year (for tax year 2013, this threshold amount is $11,950).
What is Included in Net Investment Income
In general, investment income includes, but is not limited to: interest, dividends, capital gains (including gains from the sale of a business that is passive), rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC section 469). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income.
What are some common types of income that are not Net Investment Income?
Wages, unemployment compensation; operating income from a nonpassive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, and distributions from certain Qualified Plans (those described in sections 401(a), 403(a), 403(b), 408, 408A, or 457(b)).
Will I have to pay both the 3.8% Net Investment Income Tax and the additional .9% Medicare tax?
You may be subject to both taxes, but not on the same type of income.
The 0.9% 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.
Example of the Calculation of the Net Investment Income Tax
How does a Single taxpayer with income greater than the statutory threshold calculate the Net Investment Income Tax?
Taxpayer, a single filer, has $180,000 of wages. Taxpayer also received $90,000 from a passive partnership interest, which is considered Net Investment Income. Taxpayer’s modified adjusted gross income is $270,000.
Taxpayer’s modified adjusted gross income exceeds the threshold of $200,000 for single taxpayers by $70,000. Taxpayer’s Net Investment Income is $90,000.
The Net Investment Income Tax is based on the lesser of $70,000 (the amount that Taxpayer’s modified adjusted gross income exceeds the $200,000 threshold) or $90,000 (Taxpayer’s Net Investment Income). Taxpayer owes NIIT of $2,660 ($70,000 x 3.8%).