Investing can bring you incredible returns, but when you make money, you can surely find Uncle Sam looming nearby. Each year, many high-income taxpayers find themselves struggling to figure out what their net income investment tax liability is.
There are several key factors at play when calculating that number. Are you curious to find out if you need to pay the net income investment tax this upcoming tax year? This brief tax guide will go over net investment income tax and who you can reach out to for more information and guidance.
What Is Net Investment Income Tax?
Net investment income tax, also known as NIIT, is a 3.8% tax on investment income that usually only applies to high-income taxpayers. It also may apply for estates, families, individuals, and trusts that meet certain tax income thresholds.
These NIITs can be interest, capital gains, or dividends. If you own rental properties that produce income, they can also be net investment income.
Other sources of net investment income:
- Royalty or annuity income
- Interest on loans you extended to others
- Capital gains distributions from mutual funds
NIITs also include any income derived from a business or trade classified as passive income. It is also from income derived from business trading financial commodities or instruments.
How Net Investment Income Tax Works
When you sell any type of investment, you will notice that it will either make money or you will lose money if you sell for less than what you invested in an asset. In net investment income, any tax-exempt state interest is not included.
This means that any gains from the sale of your primary residence are spared when the gain is excluded from your income for tax purposes. Any profits realized from property held in a business or trade are also exempt. It is also imperative to note that net investment income does not include any unemployment compensation, social security benefits, self-employment income, or alimony.
Where Net Investment Income Tax Originated
The net investment income tax was a part of the Health Care and Education Reconciliation Act of 2010. The net investment tax did not go into effect until January 2013.
The intention of this tax was to help raise revenue. The Joint Committee on Taxation initially estimated that this net investment income tax would generate around $36 billion in tax revenue for the tax year.
The name of the income tax is under the Unearned Income Medicare Contribution, which suggests that the tax revenue is used to fund Medicare, but it is not. Instead, the funds from this tax revenue actually go towards the nation’s general fund.
Do I Have to Pay Net Investment Income Tax?
As mentioned earlier, you only need to pay the net investment income tax if you meet a certain income threshold and filing status. You will most likely need to pay this tax if you have invested income.
Filing statuses and income thresholds that qualify for the net investment income tax:
- Single or head of household: $200,000
- Married filing jointly: $250,000
- Married filing separately: $125,000
- A qualified widow with a child: $250,000
If you meet the listed thresholds, you may need to pay this tax in addition to your income tax obligation. You are only subject to this tax if you have net investment income and your modified adjusted gross income exceeds those thresholds.
It is crucial to note that the net investment income tax is applied to the lesser of your MAGI amount or your net investment income in excess of the already predetermined limit. For example, let’s say you are a single tax filer with a net investment income of $21,055 and a gross income of $188,000.
Your modified adjusted gross income would be $209,055. The threshold for a single filer is $200,000.
Since your MAGI is more than the limit by $9,055, you would need to pay a net investment income tax of $344.09. You can calculate this tax amount by multiplying 3.8% by the excess of $9,055.
United States Citizens and Resident Aliens
The net investment income tax applies to any resident alien or United States citizen that meets the tax threshold. This tax does not apply to any non-resident aliens unless they elect to be treated as a resident of the United States for tax purposes.
If non-resident aliens do declare they wish to be treated as a resident of the U.S., they can file joint married tax returns. If the non-resident is already married to a U.S. resident or citizen, they are subject to the tax.
Estates and Trusts
This net investment income tax is also imposed on trusts, individuals, and estates. This tax applies to trusts and estates when they have net investment income and adjusted gross incomes for the year exceed the highest tax bracket dollar amount. Trusts and estates are also subject to the net investment income tax if they have undistributed net investment income.
Note About Trusts and Net Investment Income Tax
Any grantor trusts such as charitable remainder trusts are exempt from the net investment income tax. In general, taxes on grantor trusts are payable by the grantor or the individual who maintains and forms them.
To figure out the net investment income tax, investment companies will need to look at the amount of income left after any operating expenses are subtracted from the total investment income. The amount is typically expressed on a per-share basis.
If you want to find the net investment income per share of a specific company, you must divide the total investment income by the outstanding shares. This amount is available to shareholders as dividends. All publicly-traded companies must list their net investment income on their balance sheets.
Understanding Net Investment Income
If you are an investor who sells an asset from your portfolio, the proceeds from the sale are either a realized loss or gain. Your realized gains can be capital gains from selling stock or dividends paid to shareholders of a company.
Examples of other realized gains:
- Rental income received from a property
- Certain annuity payments
- Interest income from fixed income products
The main difference between any gains and trade fees or commissions is the net investment income. This net investment income could either be positive or negative depending on if the sale was a loss or again.
Net Investment Income Examples
Let’s look at an example of how to calculate net investment income. We have an individual who sells 50 shares of NFLX for $170 per share and 100 shares of AAPL for $175 per share. This person also received coupon payments for their corporate bonds for $2,650, and they also had a rental income of $16,600.
Their capital gains from APPL is $3,500. You can calculate this as: (Cost 140 – sale price 175) x100.
Capital loss from NFLX is $1,500. This is calculated by (Cost 200 – Sale Price 170) x50.
Brokerage commissions equal $35. Interest income equals $2,650.
We can then input the rental income of $16,600 and tax preparation fees of $160. When you calculate all of these figures, you will find that this individual’s net investment income is $21,055 for the year.
How to Pay the NIIT
How do you pay the net investment income tax? You can file your IRS Form 8960 with your tax return if you are subject to the NIIT. There are instructions on the form that help you determine what you owe.
Estates, trusts, and individuals use the same net investment income tax form. If you have any questions about filling out this form, you can always reach out to your tax professional for more information. It is essential to keep in mind that if you do owe this tax, you will need to make estimated quarterly payments on the amount you estimate to owe.
Calculate Your Modified Adjusted Gross Income
If you need help calculating your modified adjusted gross income (MAGI), you can always reach out to your tax advisor for assistance. You can also use your IRS Form 1040 to help calculate your MAGI.
First, you will want to start with your adjusted gross income, which is on line eleven of your Form 1040. Second, you will want to add certain deductions, such as foreign housing costs and the foreign earned income exclusion.
The number you end up with is your modified adjusted gross for net investment income tax. Be mindful that this number you get may be slightly different from your modified adjusted gross income from other tax calculations.
If you still need help figuring out your modified adjusted gross for your net investment income tax, you can use the MAGI worksheet on page 19 in the instructions for form 8960 for help. If your net investment income is less than your MAGI over the listed tax threshold, you will only need to pay 3.8% of the amount instead.
Account For Deductions
You have to keep in mind that this is net income. Trade commissions or any fees are deducted from your realized gain.
You have the opportunity to subtract your expenses from your total gain, including costs you may have incurred to maintain your investments. For example, if you have any tax preparation fees, you can subtract those.
Other deductions you can use to reduce net investment income:
- Brokerage fees
- Deductions related to producing any royalty or rental income
- Deductions related to producing income for a trade
- Deductions related to any business that generates passive income
- Investment interest expenses
- Casualty losses related to disposed or sold property
- Theft losses associated with any disposed or sold property
- The portion of your state income tax related to net investment income
It is important to note that some of these deductions are already included in your investment income. For example, any business, rental, royalty, income will already be a net amount after losses or deductions are taken into account. Any net capital gains are also already a net amount.
However, other deductions are not already included in your net figures, so you must deduct them against investment income. Those separate deductions include penalties for early withdrawals of savings, investment expenses, casualty losses related to investment properties, and investment interest.
How to Manage Net Investment Income Tax
Even if you earned a significant amount of investment income this past year, you still have the opportunity to reduce your tax liabilities. A fantastic way to reduce your modified adjusted gross income is to maximize your contributions to qualified retirement plans and IRAs.
If you also participate in deferred compensation plans, that can also help to reduce your liability. If you can reduce your modified adjusted gross income not to exceed the threshold, you may not need to pay any net investment income tax.
Another way to reduce your net investment income is through tax-loss harvesting. When you sell unprofitable investments at the same time as your profitable ones, you can significantly reduce your net investment income, which reduces your tax liability burden. If you make charitable contributions, that can also reduce your net investment income tax.
Help With Net Investment Income Tax
Calculating net investment income tax on your own can prove to be exhausting or daunting. There is so much information you need to review to see if you even exceed the threshold.
Even more so, trying to find ways to reduce your tax liability legally can also be exhausting, especially if you are unsure of what to look for. If you don’t already have a tax professional and you’re tired of trying to figure out your net investment income, it would be best to reach out to a knowledgeable tax professional.
When you partner with a reputable tax preparer for your net investment income tax 2022, they can save you more money than you would on your own. Although you will need to pay for their services, the cost is worth it. They know current tax rules and can find you credits or deductions that you may or may not be aware of.
Reduces Risk of Errors
A licensed and knowledgeable tax preparer can significantly reduce your chances of errors on your tax return. This decreases the likelihood that you will be subject to an audit from the IRS.
Saves You Time
When you turn the responsibility of filing your taxes to a tax professional, they can get it filed quicker. They know about the proper forms and documents that you need to complete your return.
This will significantly reduce the time you will need to figure out what information you need and where to put it. It also relieves you of your stress of wondering or worrying if you filed correctly.
Contact a Tax Preparer Today
The last thing any high-income taxpayer wants to do is have errors on their tax return, triggering an audit. Sure, you could figure out if you owe the net investment income tax on your own, but what about those available deductions and credits.
When you partner with a reputable tax professional, they will take the burden of reducing your tax liability away from you. They will also ensure that you get the best returns possible.