Net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities. Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income.
If an individual has income from investments, the individual may be subject to net investment income tax. Effective Jan. 1, 2013, individual taxpayers are liable for a 3.8 percent Net Investment Income Tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds the statutory threshold amount based on their filing status.
How To Calculate The Net Investment Income Tax
To calculate the NIIT, let’s first look at the statutory threshold amounts.
Married filing jointly — $250,000,
Married filing separately — $125,000,
Single or head of household — $200,000, or
Qualifying widow(er) with a child — $250,000.
Additionally, net investment income does not include any gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes. To the extent the gain is excluded from gross income for regular income tax purposes, it is not subject to the Net Investment Income Tax.
If an individual owes the net investment income tax, the individual must file Form 8960. Form 8960 Instructions provide details on how to figure the amount of investment income subject to the tax.
If an individual has too little withholding or fails to pay enough quarterly estimated taxes to also cover the Net Investment Income Tax, the individual may be subject to an estimated tax penalty.
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. The 0.9 percent Additional Medicare Tax applies to individuals’ wages, compensation, and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income.
Additional Medicare Tax Example
In the below example, this single tax filer has income of $199,558 from W2 (day job income). He then earns $51,164 in freelance income (1099 income) after expenses given he works additional jobs on the side to expedite his path to financial freedom. Total income is therefore $250,722.
Based on the Additional Medicare Tax law, all income for an individual above $200,000 is subject to an additional 0.9% tax. Therefore, his Additional Medicare Tax bill is $50,722 X 0.9% = $456. He has already paid (1.45% X $199,558) + (2.9% X $51,164) = $2,893.59 + $1,483.7 = $4,377.29 in Medicare taxes already. The rate is 2.9% on self-employed income because you must pay the employee and employer side.
Net Investment Income Tax Example
In the below example, the individual has earned a net investment income of $26,868 from dividends and interest and has a modified adjusted gross income (MAGI) of $252,494. The IRS states that the amount subject to the net investment income tax is the SMALLER of the net investment income or the difference between MAGI and the threshold ($200,000 for individuals, $250,000 for married couples).
Therefore, $26,868 is subject to an additional 3.8% tax, or $1,021. The individual has already paid roughly $50,000 in federal income taxes (~20% effective tax rate), along with an additional $14,000 (~5% effective tax rate) in California state income taxes already.
More Net Investment Income Tax Examples
Here are more net investment income tax examples. Notice how the NIIT taxes all investment income that is above the statutory threshold.
Adjustments to Net Investment Income
It is possible to lower your net investment income if you have the following:
- You received self-employment income from your partnership or S corporation.
- You sold business property.
- You have a capital loss carryover from 2015 which includes a loss from a business property sale.
To avoid paying the extra net investment income tax and additional medicare tax, your goal should be to earn less than $200,000 as an individual or $250,000 as a couple.
One of the best ways to be more flexible with your income is to start and operate a business. You have more flexibility in terms of receiving payment, purchasing business equipment, and investing in your companies future to adjust your income accordingly.
For example, you can ask your vendor to pay you your fourth quarter receivables in the first quarter of next year if you think taxes will be more favorable. You can also decide to purchase your top of the line Macbook Pro and a company car in the current year if your income is much too high and is expected to decline next year.
Net investment income tax is likely to stay for many more years to come. America is spending too much money to be fiscally responsible and the wealth gap continues to widen.
I wouldn’t be surprised if the NIIT continues to exist or actually increase in scope in the future.
About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate.
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