The Net Investment Income Tax (NIIT) is an extra tax introduced under the Obama administration to help pay for healthcare. Here is how to calculate the NIIT with an example given it can be confusing.
The NIIT is triggered once Modified Adjusted Gross Income (MAGI) reaches $200,000 for a single filer, $250,000 for a joint filer, $125,000 for a married person filing separately.
For a trust or estate, NIIT will apply to the lesser of undistributed net investment income (basically income not paid out to a beneficiary) or Adjusted Gross Income (“AGI”) if the trust/estate is in the top marginal tax bracket which begins at only $13,050.
The 3.8% tax applies to the lesser of the Net Investment Income or the amount by which MAGI exceeds the threshold. The word “lesser” is the key here and where so many people get confused when calculating the NIIT.
How To Calculate NIIT
Example #1: If a couple filing a joint return has a MAGI of $350,000 and Net Investment Income of $30,000, they exceed the threshold by $100,000 and the $30,000 is subject to $1,140 of tax ($30,000 X 3.8%).
Example #2: If a second couple also had $350,000 of MAGI but $200,000 was Net Investment Income, their tax would be $3,800 ($100,000 X 3.8%). Again, the NIIT is the lesser of the MAGI or the investment income.
What Does Modified Adjusted Gross Income Include?
- Wages, taxable Social Security, taxable alimony, compensation (including deferred compensation)
- Taxable distributions from IRAs, Roth IRAs, retirement plans, 529 plans, HSAs and nonqualified annuities
- Taxable interest and dividends
- Capital gains and taxable gains from the sale of other property
- Rents and royalties
What Does Net Investment Income Include?
- Capital gains
- Interest and dividends
- Rents and royalties
- Nonqualified annuity distributions
- Income from a trade or business considered a passive activity
Investment income below the NIIT threshold is almost always taxed at a more favorable rate. Take a look at the chart below about short-term and long-term capital gains tax rates for married, filing jointly for 2022. Notice how the long-term capital gains tax rate is much more favorable than the income tax rate.
The tax-efficiency and the passivity if investment income is why I’ve been so focused on building passive income my entire work life.
What Net Investment Income Does Not Include
- Wages, taxable Social Security, taxable alimony, deferred compensation, and self-employment income subject to self-employment taxes
- Pensions or taxable distributions from IRAs, Roth IRAs, retirement plans
- Tax exempt income such as municipal bond interest, exempted gains from the sale of a primary residence and life insurance death benefits
- Income from a trade or business not considered a passive activity
The Ideal Income To Not Pay NIIT
If you don’t want to pay the NIIT, then you should earn an ideal MAGI of $200,000 as a single filler and $250,000 as a married joint filer. The 2022 income tax rates state that at these income levels, you will pay a marginal federal income tax rate of 24%, which is very reasonable.
Hopefully, you now know how to calculate the Net Investment Income Tax. Paying taxes is a way of supporting our country. At the same time, we should strive to optimize our tax liability and our time to live our best lives.
We learned from the student loan forgiveness income threshold the ideal income to be middle class is $125,000 per person. With up to a $125,000 per person income, you can live a comfortable middle-class lifestyle while receiving all the government subsidies.
Achieve Financial Freedom Through Real Estate
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Real estate is also one of the most tax-efficient ways to earn income and capital gains.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
Take a look at my two favorite real estate crowdfunding platforms.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.
