It's Important to Understand Net Investment Income Tax

  Everyone should know and understand how NIIT/net investment income tax can affect finances. Even though you managed in dodging the bullet by paying major income taxes using specific tax perks, deductions, and credits, there may be things you do not know. This tax usually hits earners of high investment incomes. 

The basics of net investment income tax

It’s 3.8% surtax on a part of your adjusted modified gross income that exceeds the following thresholds: 

$200,000 for single individuals or head of a family 

$250,000 for a qualifying widower or widow having a child 

$250,000 for married couples that file jointly 

$125,000 for couples that are married, but files separately 

The amounts shown above are not intended for inflation and it means that the amount won’t increase except if Congress changes it specifically by new legislations. However, there is a catch and it may benefit you. 

 

With a net investment income that is lower as your modified adjusted gross income, also known as MAGI related to these amounts, it will only be necessary to pay 3.8% on it instead. 

Surtax means it is extra, besides your obligation to income tax. It can also be in addition to the amount you paid over to Medicare by withholding from earned income or tax estimated payments. You will be held liable only if both your MAGI and net investment income exceed the threshold.  

For NIIT purposes, investment income may include, though it’s not limited to: 

Rents and royalties 

Capital gains 

Dividends 

Interest 

Investment incomes won’t include the following: 

Any distributions received from delayed compensation plans 

Stock bonus and profit-sharing plans 

Accounts for individual retirement as well as Roth IRAs 

Employee annuities 

Pension distributions 

Most income for self-employment 

Alimony 

Additionally, for an individual, net investment income won’t include any kind of gain by selling their personal property, which is left out of their gross income due to tax purposes of regular income. Because of this exclusion, it won’t be subjected to NIIT.

Any individual that owes NIIT, needs to file an 8960 form which can provide instruction details in figuring out what amount from their investment income can be subjected to tax. 

When the individual withholds too little or fails in paying sufficient estimated quarterly taxes for covering their NIIT, they might be liable for a tax estimate penalty. 

NIIT will be separated from AMT/Additional Medicare Tax that also started in January the 1st of 2013. They can be liable to both of these taxes, though it won’t be the same income type.  

A 0.9% AMT can apply to their compensation, wages, and income by self-employment higher than a specific threshold. Although, it won’t apply to any items of income that is included in their Net Investment Income.  

To what does NIIT apply

NIIT imposes on investment income a 3.8 percent tax. This includes dividends, interest, on long and short-term capital gain, royalty and rental income, as well as income from business activities which is treated from the standpoint of a taxpayer as passive. 

It may also include any gain from the main residence sale if it exceeds the exemptions of $250,000 and $500,000 in the tax bracket on related residence gains.  

With net investment income calculations, taxpayers can be allowed in deducting specific expenses which are related to the income. Granting, it might otherwise be allowed only as specific deductions for ordinary purposes of income tax.

This may include brokerage fees, interest expense and advisory fees on investments, related expenses to royalty and rental income. Plus, tax preparation fees, as well as local and state income taxes linked to investment income.  

NIIT usually applies only to specific high-income taxpayers. Especially, among taxpayers who receive gross adjusted income that exceeds $250,000 for couples that file jointly, and $200,000 in the case of a single filer. They will need to pay taxes on their investment income if it exceeds the threshold amount. 

Remember net investment income tax lurks just around every corner for taxpayers with a higher income. Therefore, it’s important to plan ahead and make sure you know and understand everything. However, it might be better to get the help from professionals that have the experience and know all the laws of income tax to assist you. Everyone’s situation is different but an experienced professional can provide you with the right information, and even help to minimize your taxes.