Investing has the potential to be a lucrative financial endeavor, although there’s a fine line between success and failure. But as with most U.S. tax law, where money’s being made, you can surely find Uncle Sam nearby. Accordingly, the net investment income tax (NIIT) will take a 3.8% bite out of a portion of your investment earnings. There are, however, a number of restrictions on what the NIIT does and doesn’t apply to. Take a look through our detailed guide below for more insight.All About the Net Investment Income Tax
The net investment income tax, or NIIT, is an IRS tax related to the net investment income of certain individuals, estates and trusts. More specifically, this applies to the lesser of your net investment income or the amount by which your modified adjusted gross income (MAGI) surpasses the filing status-based thresholds the IRS imposes. The NIIT is set at 3.8%, and that rate is relevant for both the 2018 and 2019 tax seasons.
To give some background, the net investment income tax is part of the Health Care and Education Reconciliation Act of 2010. While the NIIT might seem out of place here, it was actually created to help fund the aforementioned healthcare reforms. Ultimately, the law went into effect in 2013, giving birth to the NIIT on Jan. 1 of that year. Since then, millions of Americans have paid the tax.Who’s Subject to the Net Investment Income Tax?
Individuals are frequent net investment income taxpayers, mostly because they represent a large portion of the investment market. Only U.S. citizens and resident aliens with net investment income that exceeds the MAGI thresholds in the table below need to pay the NIIT, though. On the other hand, non-resident aliens are not subject to this tax. The only exception is if they elect to be treated as a resident so they can file jointly with their U.S. citizen or resident spouse. Check out the exact thresholds here:Net Investment Income Tax (NIIT) Thresholds Your Filing Status Threshold Amount 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
Estates and trusts may also need to pay the NIIT. This pertains to estates and trusts that have both undistributed net investment income and adjusted gross income past the dollar amount at which the highest estate/trust tax bracket begins for the current tax year. The IRS stipulates that there are a few types of trusts not subject to the NIIT, including:
The entire investment market is based on the purchase and sale of investments, such as stocks, bonds, mutual funds, real estate and more. In order to turn a profit, investors aim to buy investments at a lower price than they’ll eventually sell them for. But there are many different kinds of investments, and not all of them are included as net investment income. Scroll down to see what is and isn’t subject to the NIIT:Net Investment Income (NII) Inclusions and Exclusions Included as NII Interest
Your modified adjusted gross income (MAGI) is perhaps the most important dollar amount when determining if you owe the net investment income tax. You can compute your MAGI by taking your adjusted gross income (AGI) and adding back in a few deductions, like IRA contributions, passive loss or income, taxable Social Security payments, student loan interest and more. You can find your AGI on Form 1040, Line 37.
Next, you’ll need to figure out your net investment income based on the included earnings listed above. But before you can calculate your NII, you must know your gross investment income. Once you have that, subtracting eligible deductions from your gross investment income will provide you your NII. Some common investment deductions are brokerage fees, investment advisory fees, tax preparation charges, local and state income taxes, fiduciary expenses, investment interest expenses and any costs involved with rental and royalty income.
After all this, add together your MAGI and your NII. If that total is higher than the statutory threshold for your filing status, then you must pay the net investment income tax. Earlier we stated that you pay the NIIT based on the lesser of your net investment income or the amount by which your modified adjusted gross income (MAGI) surpasses the filing status-based thresholds imposed by the IRS. In simpler terms, the dollar amount that’s subject to this 3.8% tax, will vary as follows:
Here are a few examples of NIIT:Examples of Net Investment Income Tax Filing Status Statutory Threshold Your Income Amount Subject to the NIIT Taxes Owed Single $200K $120K (MAGI) + $40K (NII) = $160K $0 $0 Single $200K $170K (MAGI) + $80K (NII) = $250K $50K $1,900 Married Filing Jointly $250K $220K (MAGI) + $45K (NII) = $265K $15K $570 Married Filing Separately $125K $150K (MAGI) + $40K (NII) = $190K $40K $1,520 How to File the NIIT
IRS Form 8960 is devoted to the calculation of the net investment income tax. When you’re ready to report and pay your NIIT, you’ll do so via Form 1040. Estates and trusts looking to file the NIIT should use Form 1041. If you come across issues or specific questions related to this tax, you may want to consult a financial advisor or a certified public accountant (CPA).
According to the IRS, if you believe that you will pay the NIIT for the current tax year, you must account for it ahead of time. This involves either adjusting your income tax withholding or setting up quarterly estimated payments. Although this requires extra work, it could save you from underpaying the IRS come tax time.Tips for Managing Your Investments
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