The net investment income tax is a 3.8% tax on investment income of investors whose modified adjusted gross income (MAGI) is over the IRS threshold. Also known as the unearned income Medicare contribution tax, it went into effect in 2013. Though this article focuses on individuals, estates and trusts are also subject to the net investment income tax (NIIT).
What Counts as Net Investment Income?
Net investment income applies to a specific list of income sources. Net investment income includes:
- Capital gains (short- and long-term)
- Interest and dividends
- Passive investment income
- Rental and royalty income
- Taxable portion of nonqualified annuity payments
- Business income from trading financial instruments or commodities
Income from all of these sources are added together to determine the total net investment income. For example, an investor could have capital gains from selling stock, rental income from a property they own and dividends from being a company shareholder.
Paying the net investment income tax does not negate the need to pay capital gains tax or dividends tax; additional taxes are owed on the income received from those sources.
Most other income is not considered net investment income. For example, wages, unemployment, alimony, Social Security or veterans’ benefits, qualified retirement plan withdrawals, income from traditional defined pensions or retirement plan annuities, life insurance proceeds and active business investment income are not subject to NIIT.
When Does Net Investment Income Tax Apply?
The net investment income tax applies to individuals who a) have net investment income and b) have a modified adjusted gross income (MAGI) that exceeds the specified levels laid out by the IRS.
Married filing jointly
Married filing separately
Head of Household (with qualifying person)
Qualifying widow(er) with dependent child
Nonresident aliens are not subject to this tax unless they are married to a U.S. citizen/resident and elect to be treated as a resident for tax purposes.
How to Calculate Net Investment Income Tax
Your net investment income tax is 3.8% of the lesser of either your net investment income or the excess of your MAGI over the threshold. For example, a couple filing a joint tax return with net investment income of $50,000 and MAGI of $270,000 would pay 3.8% of $20,000, or $760. That’s because the excess of their MAGI over the $250,000 limit ($20,000) is less than their net investment income ($50,000).
How to Reduce Your NIIT Tax Burden
There are a variety of net investment income tax strategies that can help reduce your tax liability. You can reduce your MAGI, your net investment income or both.
To reduce your MAGI, you can maximize contributions to your IRAs and qualified retirement plans, make charitable gifts to nonprofit organizations, contribute the limit to your HAS or FSA and/or defer any income you can.
To reduce your net investment income, you can adopt a tax-loss harvesting strategy and/or reduce your net investment income through charitable contributions, like a charitable remainder trust.
Your tax professional can help you with questions about how net investment income tax may impact your tax liability. If you’re looking for financial strategies to better set you up for the future, connect with a Farm Bureau agent or financial advisor.