What Is the Net Investment Income Tax?
While the Net Investment Income Tax (NIIT) most often affects wealthier individuals, in certain circumstances, it can also affect moderate-income taxpayers whose income increases significantly in a given tax year.
What Is the NIIT?
The NIIT is a 3.8 percent tax on certain net investment income of individuals, estates, and trusts with income above statutory threshold amounts.
What Is Included in Net Investment Income?
In general, net 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 financial instruments or commodities, and passive business activities such as rental income or income derived from royalties.
What Is Not Included in Net Investment Income?
The following types of income are not included:
- Unemployment compensation
- Operating income from a non-passive business
- Social Security benefits
- Tax-exempt interest
- Self-employment income
- Distributions from certain qualified plans, such as 401(k)s, and IRAs
Individuals with modified adjusted gross income (MAGI) over $250,000 (married filing jointly) or $200,000 (single and head of household filers) are taxed at a flat rate of 3.8 percent on the lesser of their net investment income or the amount by which their MAGI exceeds the applicable threshold. The NIIT is a flat rate tax paid in addition to other taxes owed, and threshold amounts are not indexed for inflation.
Non-resident aliens are not subject to the NIIT; however, if a non-resident alien is married to a U.S. citizen and is planning to file as a resident alien as married filing jointly, there are special rules. Please call if you have any questions about this.
Investment income is generally not subject to withholding, so being subject to the NIIT could cause you to owe tax when you file your return. In addition, even lower-income taxpayers who wouldn’t normally meet the threshold amounts may be subject to NIIT if they receive a windfall, such as a one-time sale of assets that significantly bumps up their MAGI.
Strategies to Minimize NIIT
Tax planning is crucial. For example, if you’re anticipating a windfall (this tax year or next), there are strategies you could use to minimize your MAGI and reduce tax liability when you file your tax return. These include but are not limited to:
- Rental real estate (depreciation deductions)
- Installment sales (including figuring out the best timing for sale)
- Charitable donations
- Tax-deferred annuities
- Municipal bonds
Sale of a Home
The NIIT doesn’t apply to any amount of gain on the sale of a principal residence that is excluded from gross income for regular income tax purposes ($250,000 for single filers and $500,000 for a married couple) . In other words, only the taxable part of any gain on the sale of a home has the potential to be subject to NIIT, providing the taxpayer is over the MAGI threshold amount.
Estates and Trusts Affected
Estates and trusts are subject to the NIIT if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such a taxable year. In 2023, this threshold amount is $14,450 ($13,450 in 2022).
Special rules apply for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts. Some trusts, including Grantor Trusts and Real Estate Investment Trusts (REITs), aren’t subject to the NIIT.
Non-qualified dividends generated by investments in a REIT and taxed at ordinary tax rates may be subject to the NIIT.
Reporting and Paying the NIIT
For tax years 2018 and beyond, individuals, estates, and trusts that expect to pay estimated taxes should adjust their income tax withholding or estimated payments to account for the tax increase and avoid underpayment penalties. The NIIT is not withheld from an employed individual’s wages; however, it is possible to request that additional income tax be withheld.
If you are wondering how the NIIT could affect your tax situation, contact the office today and find out.