What is NIIT (Net Investment Income Tax) ?
Net Investment Income Tax is a tax of 3.8% on certain investment income for individuals, estates, and trusts with income above set thresholds, introduced by the Internal Revenue Code section 1411.
The NIIT (Net Investment Income Tax) started on January 1, 2013.
Who Owes NIIT ?
- Individuals Subject to NIIT: Those with investment income and a modified adjusted gross income (MAGI) over these amounts:
- Married filing jointly: $250,00
- Married filing separately: $125,000
- Single or Head of household: $200,000
- Qualifying widow(er) with dependent child: $250,000
- Modified Adjusted Gross Income: MAGI for NIIT is your adjusted gross income plus any foreign income exclusions and certain disallowed deductions.
- Individuals Not Subject to NIIT: Nonresident Aliens (NRAs), including certain dual-resident and dual-status individuals, are not subject to NIIT.
Estates and Trusts and NIIT
- Subject to NIIT: Estates and trusts with undistributed Net Investment Income and an adjusted gross income above the threshold for the highest tax bracket (updated annually).
- Not Subject to NIIT: Trusts exempt from income taxes, certain unique trusts, grantor trusts, and trusts not classified for federal income tax purposes.
What’s Included in Net Investment Income ?
- Included: Interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and passive business income.
- Not Included: Wages, unemployment compensation, nonpassive business income, Social Security Benefits, alimony, tax-exempt interest, self-employment income, and certain qualified plan distributions.
- Types of Gains Included: Gains from the sale of stocks, bonds, mutual funds, investment real estate, and interests in partnerships and S corporations for passive owners
Sale of Personal Residence
NIIT (Net Investment Income Tax) and Personal Residence: NIIT doesn’t apply to gains from the sale of your main home that are excluded from income taxes.
For singles, up to $250,000 of gain is exempt, and for married couples filing jointly, up to $500,000.
Here’s examples.
- Example 1: A single filer, A, earns $210,000 in wages and sells his home for $420,000 with a cost basis of $200,000, realizing a gain of $220,000. Under section 121, A can exclude up to $250,000 of gain, making this gain exempt from both regular income tax and Net Investment Income Tax (NIIT).
- Example 2: A married couple, B and C, filing jointly, sell their home for $1.3 million with a cost basis of $700,000, realizing a gain of $600,000. They can exclude $500,000 under section 121, leaving $100,000 subject to regular income taxes. With other Net Investment Income of $125,000, their total NII is $225,000. Their modified adjusted gross income (MAGI) is $300,000, exceeding the NIIT threshold by $50,000. They owe NIIT on the lesser amount, which is $50,000, resulting in a tax of $1,900 (50,000×3.8% ).
- Example 3: D, a single filer, earns $45,000 in wages and sells her home for $1 million with a cost basis of $600,000, realizing a gain of $400,000. After the section 121 exclusion of $250,000, the recognized gain is $150,000. However, since D’s MAGI is $195,000, below the NIIT threshold of $200,000, she does not owe any NIIT.
Children’s Investment Income
Children’s Income on Form 1040: If you report your children’s investment income on your tax return using Form 8814, it’s included in your NIIT calculations.
However, the portion of their income that’s below the filing thresholds on Form 8814 isn’t included.
Deductible Investment Expenses
Deducting Expenses: You can deduct certain expenses related to your investment income, like:
- Investment interest expense
- Advisory and brokerage fees
- Rental and royalty expenses
- Tax preparation fees
Additional Medicare Tax vs NIIT
Different Taxes: The 3.8% NIIT and the 0.9% Additional Medicare Tax may both apply, but not on the same income.
The Additional Medicare Tax is for wages and self-employment income above certain thresholds, not investment income.
Reporting and Paying NIIT
Form 8960: Use Form 8960 to calculate NIIT. Individuals report and pay this tax with Form 1040, while estates and trusts use Form 1041.
Withholding from Wages
No Automatic Withholding: NIIT isn’t automatically withheld from wages, but you can request additional withholding to cover it.
Calculation Examples
Below Threshold: If your income is below the NIIT threshold, you don’t owe NIIT.
Above Threshold: If your income exceeds the threshold, you owe NIIT on the lesser of your net investment income or the amount by which your income exceeds the threshold.
- Example 4: A single taxpayer earns $180,000 in wages and $15,000 from dividends and capital gains. Their total income is $195,000, which is below the NIIT threshold of $200,000. Therefore, they don’t owe any NIIT.
- Example 5: Another single taxpayer has $180,000 in wages and $90,000 from a passive partnership, totaling $270,000 in income.
This is $70,000 above the NIIT threshold. They owe NIIT on the lesser amount, which is the excess over the threshold ($70,000), resulting in a NIIT of $2,660 (calculated as $70,000×3.8% ).
