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Chances are, if you paid it last year, you’ll be paying it this year too … and you also know what NIIT means! If you don’t know, rest assured, you will learn the basics for the NIIT right now.
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The Net Investment Income Tax (NIIT) is also known as the “Medicare” surtax because the legislation enacting this tax was created with a new chapter of the tax code entitled: Chapter 2A – Unearned Income Medicare Contribution.
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However, this was simply a revenue-raiser enacted to offset the cost of health care legislation; there is no requirement that this surtax be used for Medicare. As of late 2013, with new regulations set in order, the IRS named this surtax only as the Net Investment Income Tax.
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As a quick explanation for the first paragraph, surtaxes are generally imposed on top of other taxes and they affect persons who are already paying taxes rather than extending taxation to new areas or persons who have not previously been taxed.
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- The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.
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In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income (deductible investment expenses include: legal and professional fees, travel and transportation costs, investment related publications and software, safe deposit box rental, etc.).
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To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing the Net Investment Income:
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- Gains from the sale of stocks, bonds, and mutual funds;
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- Capital gain distributions from mutual funds;
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- Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence);
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- Gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).
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Normally, net investment income doesn’t include wages or salaries, even if they are a result of self-employment. Social Security benefits, unemployment compensation, distributions from certain Qualified Plans, tax-exempt interest, or alimony payments are also not considered net investment income. Additionally, it doesn’t cover any profit from the sale of your home that’s excluded from your income.
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Once you’ve totaled your investment income, you can deduct any credits that qualify. (If the tax credit is allowed only against the tax imposed as regular income tax, that credit may not reduce the NIIT.)
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| Modified adjusted gross income (MAGI), for purposes of the NIIT is generally defined as adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned income exclusion (but also adjusted for certain deductions related to the foreign earned income). For individual taxpayers who have not excluded any foreign earned income, their MAGI is generally the same as their regular AGI. |
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You owe the tax if you have Net Investment Income and also have modified adjusted gross income over the following thresholds:
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 Married filing jointly - $250,000 |
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Married filing separately - $125,000
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| Single - $200,000 |
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Head of household (with qualifying person) - $200,000
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Qualifying widow(er) with dependent child - $250,000
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| You should be aware that these threshold amounts are not indexed for inflation. |
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| The fact that you pay or don’t pay Medicare taxes has no impact on the Net Investment Income Tax if you have Net Investment Income and also have modified adjusted gross income over the applicable thresholds. |
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Also, the Net Investment Income Tax is separate from the Additional Medicare Tax (which also went into effect on January 1, 2013). You may be subject to both taxes, but not on the same type of income.
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| The 0.9% Additional Medicare Tax applies to wages, compensation, and self-employment income over certain thresholds, but it ddoes not apply to income items included in Net Investment Income. |
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| In the case of estates and trusts, the NIIT applies on the lesser of: |
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- Undistributed net investment income; or
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- The excess of adjusted gross income over the amount of the highest regular income tax bracket in effect for that taxable year.
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| For estates and trusts, the 2014 threshold is $12,150. For tax year 2015, the highest regular income tax bracket for trusts and estates (39.6%) begins with taxable income in excess of $12,300. |
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| As mentioned above, The NIIIT tax base of trusts and estates is undistributed net investment income which is any net investment income that is retained by a trust or an estate. Distributions retain their characterization as net investment income when distributed to a beneficiary. If the trust has net investment income that is distributed to a beneficiary, it will be characterized as net investment income for the beneficiary. |
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| Individual taxpayers, as well as estates, and trusts have to use Form 8960 and the Instructions to the form to compute their Net Investment Income Tax. |
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| For individuals, the tax is reported on, and paid with, Form 1040, Line 60. For estates and trusts, the tax is reported on, and paid with, Form 1041 (Estate and Trust Income Tax Return) Schedule G, Line 4. |
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| If you expect to be subject to the NIIT tax next year you should adjust your income tax withholding or estimated payments to account for the tax increase in order to avoid underpayment penalties. |
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| As you certainly assumed by now, professional expertise is indispensable in navigating through the complexity of the IRS rules and regulations regarding the NIIT, as well as other tax issues that may apply to your particular situation. |
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