What is Net Investment Income Tax (NIIT) and who pays it?

VaselineOctober 1, 2024

0 3 minutes read

What is Net Investment Income Tax (NIIT) and who pays it?

If you don’t know what Net Investment Income Tax (NIIT) is, you’re not alone. This relatively new tax began just over a decade ago, but the number of taxpayers subject to the tax has grown.

For example, show the data that 3.1 million taxpayers were subjected to NIIT in its first year. Just eight years later, this number has doubled.

So what is NIIT and who has to pay it?

Subscribe to Kiplinger’s Personal Finance

Be a smarter, more informed investor.

Save up to 74%

Sign up for Kiplinger’s free e-newsletters

Profit and prosper with the best expert advice on investments, taxes, retirement, personal finance and more – straight to your email address.

Profit and prosper with the best expert advice – straight to your email address.

Read on to avoid surprises on your next tax bill and learn how you can reduce your net investment income.

What is the net investment income tax?

The net investment income tax is a 3.8% tax that you must pay if your modified adjusted gross income (MAGI) exceeds a certain threshold. (More on that later).

Taxpayers who meet that income threshold pay tax on the lesser of:

Net investment income, OR
Amount in excess of MAGI

The income thresholds are not indexed for inflation, meaning that if inflation were to rise, you would pay a higher percentage of tax on the same investment value.

Why do I pay tax on net investment income?

Below are the MAGI thresholds that make you eligible for NIIT:

Married filing separately – income over $125,000
Single filers or head of household – income over $200,000
Married filing jointly – income over $250,000

If you have investment income and your MAGI is less than the above amounts, you will not have to pay NIIT.

What counts as net investment income?

Different types of income may be subject to the 3.8% tax, although not all. Below is a list of common examples of investment income that falls under NIIT:

Additionally, non-qualified annuities (mutual funds, CDs, etc.) may be subject to NIIT.

It is important to consult with a tax professional to determine whether an investment you own is subject to a particular tax.

What is exempt from NIIT?

Several types of income are not subject to NIIT. For example, qualified annuities might be part of a retirement plan, so they may be subject to different tax rules. (For example: 401(k)s, 403(b)s, 457(b)s and IRAs).

Other types of income generally exempt from NIIT include:

How to avoid tax on net investment income

Here are some types of expenses that can help reduce your net investment income. Note that these do not necessarily help you avoid tax entirely. Rather, spending can help reduce NII, potentially lowering NIIT liability.

Interest expense on investments
Investment advisory fees (or brokerage commissions)
Rental and royalty expenses related to your rental and royalty income
Tax preparation fees
Fiduciary expenses (for estates and trusts)
Local income and state taxes

Next, we’ll use an example to demonstrate how investment income can be subject to net investment income tax.

Example of tax on net investment income

Note: Note that this is a simple example. Real world scenarios can usually be more complex.

Example. A single filer has $175,000 in wages and $80,000 in dividends (without expenses). This means their net investment income is $80,000. Their MAGI (wages plus dividends) is $255,000.

In this case, MAGI exceeds the threshold level for a single filer under NIIT ($200,000). This means that the single filer will be subject to tax.

NIIT will take the lesser of:

The amount the taxpayer exceeds the threshold ($255,000 minus $200,000 = $55,000), OR
Their investment income ($80,000)

Since $55,000 is less than $80,000, NIIT will use $55,000.

Thus, the taxpayer’s NIIT will be 3.8% multiplied by $55,000, resulting in a tax of $2,090.

Does NIIT apply to home sales?

NIIT generally does not apply to items normally excluded from the ordinary taxable incomewhich includes the sale of a principal residence.

If you plan to sell your primary home, the first $250,000 (filing single) or $500,000 (married filing jointly) is generally exempt from capital gains tax. Hence, it is generally exempt from NIIT. But what if profit from selling your home it’s over home capital gains tax exclusion limit, you may have to pay excess tax, so you may pay NIIT if your MAGI exceeds the threshold.

For more information see: Capital Gains Tax on Real Estate and Home Sales.

What is the 3.8% Medicare surcharge?

If you are an exempt taxpayer Medicare feesyou may still owe NIIT if you meet the investment and MAGI criteria. While you may be subject to the 0.9% Medicare tax and the 3.8% investment tax, you won’t be subject to both on the same type of income.

Note: Although both are additional fees, they are separate fees with different rules. Also, fun fact: the “Medicare tax” does not currently fund Medicare. It is a separate tax that goes to the general fund.

For more information, see The Medicare Tax: Five Things Every Worker Needs to Know.

IRS Tax on Net Investment Income: More Information

If you want to learn more, the IRS has published a list of NIIT FAQs.

In addition, you can also find a retention estimator on the IRS website, which can help you estimate federal income tax withholding, including NIIT.

VaselineOctober 1, 2024

0 3 minutes read

Vaseline

Related Articles

Hiscox Ltd: attractive in ongoing insurance market

Data center AI and PC demand make AMD a business

Boeing Starliner emitting strange noses

Knowles Co. (NYSE:KN) Brief Interest Update