What Is the NIIT?
The Net Income Investment Tax was imposed beginning in 2013 to help fund the Affordable Care Act. The NIIT is contained in Section 1411 of the Internal Revenue Code and applies a tax rate of 3.8 percent to the net investment income of individuals, estates, and trusts that have income above specific thresholds. It applies to income from these sources:
- Short or long term capital gains
- Rental or royalty income
- Passive business income
- Income from a business that is involved in trading financial instruments or commodities
- Nonqualified annuity payments
But not these:
- Social Security benefits
- Unemployment compensation
- Life insurance proceeds
- Income from a non passive business
- Tax-exempt interest
- Tax-exempt capital gains
- Deferred compensation from a tax-exempt organization
- Retirement or pension plan payments
Who Pays the NIIT?
Taxpayers with modified adjusted gross incomes (MAGI) higher than the specified thresholds must pay the tax. The amounts are as follows:
Single or head of household: $200,000
Married filing jointly: $250,000
Qualifying widow(er) with child: $250,000
How Do I Calculate MAGI?
MAGI can be determined by starting with your AGI (adjusted gross income) and adding back some deductions:
- ½ of the self-employment tax
- Student loan interest
- Tuition and fees
- Passive income or loss
- Rental losses (unless deemed active)
- IRA contributions
- Taxable social security payments
- Certain adoption expenses
- Certain income from savings bonds
- Excluded foreign income
MAGI and AGI may be similar or even identical in many cases. If your MAGI is above the threshold, gains that are not otherwise offset by capital losses are included in the income that is subject to the NII. The IRS points out these common examples:
- Capital gain distributions from mutual funds
- Gains from the sale of real estate, including the sale of a second home (but not a qualifying primary residence)
- Profits from the sale of stocks, bonds, and mutual funds
- Profits from the sale of your interests in a partnership or an S corporation if you were a passive owner
As noted, the excluded gain on the sale of a primary residence ($250,000 for a single taxpayer or $500,000 for a married couple, subject to residence rules) would be excluded from the NIIT as it is excluded from income.
How Do Impacted Taxpayers Report and Pay the NIIT?
Individual taxpayers, as well as estates and trusts subject to the NIIT, use IRS Form 8960 to calculate and pay their NIIT of 3.8% on the required income. Individuals will file the form with their 1040, while estates and trusts will submit it as part of their 1041 filing. Taxpayers should be aware that NIIT is part of estimated tax provisions but is not withheld from wages. Therefore, if a taxpayer anticipates needing to pay the tax in a future tax year, consider having withholding increased to include the amount and avoid potential underpayment penalties.
Since this obligation is complex, taxpayers should consider seeking the advice of their own financial and tax advisors.