What is the tax on net investment income?

The net investment income tax is a 3.8% surcharge on a portion of your modified adjusted gross income (MAGI) above certain thresholds. It is generally paid by high-income individuals with significant investment income.

Net investment income tax may still apply to your finances, even if you manage to avoid paying significant income taxes on your investment income by using deductions, credits, and other tax advantages. Find out how it works and who should pay.

Definition and examples of net investment income tax

The net investment income tax is a 3.8% tax on investment income that generally applies only to high-income taxpayers. It applies to individuals, families, estates and trusts, but certain income thresholds must be met before the tax takes effect.

Net investment income can be capital gains, interest, or dividends. It can include income from rental properties, distributions of capital gains from mutual funds, and even income from royalties or annuities and interest on loans you might have given to others.

Includes income derived from an operation or business that is classified as passive income and income from trading of financial instruments or raw materials.

How does the net investment income tax work?

When a taxpayer sells virtually any type of investment, they will make a profit or a loss: they will make money or lose money if they sell for less than they have invested in the asset. But there are some exceptions.

Tax-exempt state interest is not included in net investment income. Gains from the sale of a principal residence are saved when the gain is excluded from income for income tax purposes. Earnings on property held in an industry or business are also exempt.

Net investment income does not include wages, self-employment income, unemployment compensation, Social Security benefits, or alimony.

How the tax on net investment income was developed

The net investment income tax was legislated as part of the Health Care and Education Reconciliation Act of 2010, which went into effect in March 2010. However, the net investment income tax went into effect on January 1, 2013.

The net investment income tax was included as part of that legislation to increase revenue. The Joint Committee on Taxation estimated that the tax would generate $36.6 billion in tax revenue in fiscal year 2021.

The official name for net investment income tax is under a program known as “Medicare Tax on Unearned Income.” This suggests that tax revenue is used to fund Medicare, but the revenue raised by this tax actually goes into the nation’s general fund. In fact, you may be subject to net investment income tax even if you’re exempt from additional Medicare tax because these two taxes apply to different types of income.

Do I need to pay tax on net investment income?

Net investment income tax thresholds are based on your filing status and income. You may be subject to this tax if you have investment income and your modified adjusted gross income exceeds certain thresholds.

Civil status income threshold
Single or head of household $200,000
Married Filing Jointly $250,000
Married Filing Separately $125,000
Qualifying widow(er) with one child $250,000

This tax is paid in addition to your income tax liability. It’s also on top of what you paid into Medicare through earned income withholding or estimated tax payments. But you are only subject to this tax if you have net investment income Y his MAGI exceeds these thresholds.

Tax on net investment income is imposed on estates and trusts, as well as on individuals.

For individuals, it applies to US citizens and resident aliens. It does not apply to nonresident aliens unless they have elected to be treated as US residents for tax purposes so they can file joint married tax returns.

Net investment income tax applies to estates and trusts when they have net investment income and adjusted gross income for the year that exceeds the dollar amount in which the highest tax bracket begins.

Grantor trusts and trusts that are exempt from income taxes, such as charitable remainder trusts, are exempt from net investment income tax. In most cases, taxes on grantor trusts are payable by the individual, the grantor, who formed and maintains them.

How do I pay the tax on net investment income?

File IRS Form 8960 with your tax return if you are subject to net investment income tax. The form comes complete with instructions to help you determine how much you owe, and should be used by individuals as well as estates or trusts.

Keep in mind that if you owe this tax, you’ll need to make quarterly estimated payments on the amount you think you’ll owe, in addition to quarterly income payments.

Calculate your MAGI

Your IRS Form 1040 can help you figure your net investment income tax. First, calculate your MAGI. Start with your adjusted gross income (see line 11 of your Form 1040).

Second, add back certain deductions, including:

  • The Foreign Earned Income Exclusion
  • Housing costs abroad

This number is your modified adjusted gross income for net investment income tax, which may be slightly different from your MAGI for other tax calculations.

You can use the MAGI worksheet included on page 19 in the instructions for Form 8960 to calculate your MAGI for net investment income tax.

If your net investment income is less than the portion of your MAGI above the tax thresholds, you would pay 3.8% of this amount instead. Next, you need to compare your MAGI to your net investment income for the year.

Account for Deductions

Remember, this is net entry. Commissions or trading fees are deducted from the amount of profit made. You can subtract your expenses from your total realized profit, including any costs you incurred to maintain these investments, such as tax preparation fees.

Other deductions that can reduce net investment income include:

  • Deductions related to the production of rents and royalties
  • Deductions related to the production of business income for a trade or business that is a passive activity or trade in financial instruments or commodities
  • Investment interest expense
  • brokerage fees
  • The portion of state income tax that relates to net investment income
  • Casualty and theft losses related to property that was sold or disposed of

Some of these deductions are already included in the investment income figures. For example, rental income, royalty income, business income, and net capital gains will already be a net amount after any deductions or losses have been taken into account.

However, other deductions are not included in these net figures, so they must be deducted from investment income to arrive at net investment income. These separate deductions include the penalty for early withdrawal of savings, investment interest, investment expenses, state income taxes allocated to investment income, and casualty and theft losses related to investment property.

Calculate your net investment income tax liability

Net investment income tax is due on the lesser of your undistributed net investment income or the portion of your MAGI that exceeds the thresholds.

Multiply the bottom number by 0.038 (3.8%). This is the amount of net investment income tax you will pay.

key takeaways

  • The Net Investment Income Tax (NIIT) is a 3.8% tax on investment income, such as capital gains, dividends, and property rental income.
  • This tax only applies to high-income taxpayers, such as single taxpayers making more than $200,000 and married couples making more than $250,000, as well as certain estates and trusts.
  • This tax was created to help finance the expansion of Medicare, but the revenue technically goes into the general fund.

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