If you earn a high income and have significant investment income, you might be subject to the Net Investment Income Tax, known as NIIT.
The Net Investment Income Tax is a 3.8% surtax that applies if you have investment income and your modified adjusted gross income (MAGI) is above a certain threshold. This tax has been in place since 2013 and it impacts tax returns for individuals as well as estates and trusts. If you’re in a high capital gains tax bracket, there’s a chance you have to pay NIIT on your upcoming tax return.
If you’re wondering if you need to pay NIIT and how to actually file your taxes, our guide is covering everything you need to know.
What Is Net Investment Income?
If you earn income through investing, you’re generating net investment income (NII). Additionally, if you’re a landlord who earns rental income, you’re also creating NII. According to the IRS, net investment income includes sources like:
- Capital gains
- Dividends
- Non-qualified annuities
- Rental and royalty income
- Taxable interest
Net investment income can also include passive income from a business as well. However, wages, Social Security Benefits, unemployment pay, alimony, and many forms of self-employment income don’t typically count as net investment income.
As an example, let’s say you sold Tesla stock this year for $15,000 in profit. Let’s also assume you earned $500 in taxable interest and $1,000 in dividend income this year. This results in $16,500 in investment income. However, you also incurred $250 in brokerage fees. This lowers your net investment income to $16,250 for the year.
What Is The Net Investment Income Tax (NIIT)?
The Net Investment Income Tax was introduced as part of the 2010 Health Care and Education Reconciliation Act and went into effect at the start of 2013. NIIT’s purpose was to help fund the bill's various reforms.
NIIT has a 3.8% rate but it only applies if you have net investment income and a modified adjusted gross income that’s above the threshold for your filing status. These are the current net investment income tax thresholds outlined by the IRS:
Net Investment Income Tax Thresholds | |
|---|---|
Filing Status | Threshold |
Single | $200,000 |
Married filing jointly | $250,000 |
Married filing separately | $125,000 |
Head of household (with qualifying person) | $200,000 |
Qualifying widow(er) with dependent child | $250,000 |
U.S. citizens and resident aliens with net investment income and a MAGI that exceeds these thresholds will need to pay NIIT. Non-resident aliens don’t need to pay this tax unless they marry a U.S. citizen or U.S.-residing spouse and file taxes jointly.
Estates and trusts must pay Net Investment Income Tax if they have undistributed net investment income plus adjusted gross income over the dollar amount at which the highest estate and trust tax bracket begins for that year.
How Is The NIIT Calculated?
The NIIT tax rate is 3.8%. However, this percentage only applies to the lesser of your net investment income or the portion of your MAGI that’s over the threshold for your filing status.This means you need to know three numbers to calculate your NIIT:
- Your net investment income
- Your MAGI
- The NIIT MAGI threshold for your filing status
Calculating your net investment income requires calculating gross investment income and then subtracting eligible deductions like tax preparation costs, brokerage fees, state income taxes, and even costs like running your rental properties.
In terms of calculating your modified adjusted gross income, you first need to calculate your adjusted gross income (AGI). This requires calculating gross income, which includes sources like wages, dividends, capital gains, and business income. You also subtract adjustments to income like student loan interest and alimony payments. Refer to 1040 instructions for more information on how to calculate AGI.
Once you know your AGI, you calculate your MAGI. This is basically adjusted gross income with various deductions or tax credits. However, for some investors, AGI and MAGI are the same number. Healthcare.gov has a useful guide for how to estimate your MAGI.
Examples Of The NIIT
After calculating your NII and MAGI, you’re ready to determine what amount is subject to the 3.8% net investment income tax. Remember, you only pay 3.8% on the lesser of net investment income or by the amount your MAGI exceeds your filing threshold.
Let's say that two single filers have the exact same MAGI of $260,000, but the first filer has Net Investment Income of $20,000 while the second filer's Net Investment Income is $100,000. Here's how the Net Investment Income Tax would be calculated for each filer.
Filing Status | Threshold | MAGI | Net Investment Income (NII) | Amount Subject to NIIT | NIIT Owed |
|---|---|---|---|---|---|
Single | $200,000 | $260,000 | $20,000 | $20,000 | $760 |
Single | $200,000 | $260,000 | $100,000 | $60,000 | $2,280 |
As you can see, these two scenarios are quite different. In scenario one, you pay 3.8% tax on your $20,000 of NII because it’s lower than the $60,000 amount you exceed the MAGI threshold by. However, in scenario two, you pay 3.8% tax on the $60,000 amount that your MAGI exceed's the threshold since it's less than your $100,000 of NII.
How Do You Report The Net Investment Income Tax?
Form 8960 helps you calculate your net investment income tax. If you have to pay NIIT, you do so with Form 1040 if you’re filing as an individual and with Form 1041 if you’re filing as an estate or trust.
If you need help with filing your taxes, you may want to consult a certified public accountant (CPA), especially if you’re new to paying NIIT.
According to the IRS, NIIT is subject to the estimated tax provisions. This means you need to estimate your NIIT amount if you think you’re going to be subject to it so you can adjust income tax withholdings or estimated payments to avoid underpaying.
Are There Ways To Avoid Paying The NIIT?
The two main ways to reduce or avoid paying net investment income tax are to lower your net investment income (NII) and MAGI.
There are several ways to reduce tax liabilities here. For starters, you can reduce your taxable income by contributing to an IRA or 401(k). Contributing to a health savings account (HSA) or flexible spending account (FSA) are also viable strategies. For self-employed individuals, tactics like deferring income or business expense deductions also lower taxable income.
As for lowering your net investment income, you also have options. The first and most obvious step is to have thorough record-keeping so you can claim tax deductions like brokerage fees. You can also consider tax-loss harvesting to partially offset your capital gains.
The bottom line is that very high-income individuals probably have to pay NIIT. However, you can reduce how much you pay with proper bookkeeping and tax preparation tips.
Final Thoughts
If you have to pay Net Investment Income Tax, you can try filing taxes yourself or with popular tax software like TurboTax or H&R Block. Or if you'd like one-on-one help, you could consult a certified financial planner (CFP) or CFA for assistance.
Tom Blake is a personal finance writer with a passion for making money online, cryptocurrency and NFTs, investing, and the gig economy.
