Who Pays Net Income Investment Tax (NIIT)?

Posted by Grace Copeland on Sep 17, 2021


In a previous article, we discussed the concept of net investment income tax (NIIT). We outlined the fact that the 3.8% NIIT under the auspices of 26 U.S. Code § 1411 - “Imposition of Tax,” and is applied to net investment income (NII).

And we pointed out that NII consists of income from your investment assets. Those assets can include stocks, mutual funds, loans, and rental income from properties. Royalties, annuities, and dividend payments can also be subject to NIIT. And capital gains from the sale of a capital asset could also require an NIIT payment.

But if you’re someone who depends on income from such investments, are you automatically required to report, and pay, that 3.8% NIIT? 

Not necessarily. First of all, the tax depends on your modified adjusted gross income. And second, there are ways in which you could potentially avoid paying that NIIT.

A MAGI Primer

The IRS differentiates from adjusted gross income (AGI) and modified adjusted gross income (MAGI). Let’s take a careful look at these.

The adjusted gross income is your overall gross income, less adjustments. “Income,” in this case, includes wages and salaries, dividends, rental income, unemployment, business income, alimony, and retirement distributions or withdrawals. 

Items that “adjust” this income can include retirement account contributions, moving expenses, self-employment taxes, education expenses, and student loan interest. Basically, the AGI is the total taxable income before itemized or standard deductions are factored into the equation.

The AGI impacts how you might use various tax credits and/or exemptions.

Now, modified adjusted gross income, or MAGI, goes one step further. It requires your household income, then adds to it the tax-exempt interest income that comes along. U.S. savings bonds interest exclusion is considered exempt from taxes. So are taxable Social Security payments, passive income or loss, rental losses, qualified tuition expenses, or adoption expense exclusions.

The MAGI is used to determine if you qualify for certain tax deductions. The IRS also uses it to determine if, indeed, you meet the threshold for NIIT payments. 

MAGI thresholds are as follows:

Single/Head of Household                                                                 $200,000

Married Filing Jointly                                                                           $250,000

Married Filing Separately                                                                    $125,000

Qualified Widow/Widower with Child                                                 $250,000

Potentially Reducing The NIT

If your MAGI falls into one of the above thresholds, don’t panic. Following are ways in which you could potentially reduce the net investment income tax liability. 

Consider tax harvesting. If your capital asset is likely to lead to a large capital gain, try to time the sale of that asset with one that has a significant loss. This can help decrease overall net income.

Boost charitable contributions. Rather than taking cash payments from your securities, bonds, or even real estate, consider donating it to a charity, instead. When you do this, you won’t have to report a gain on your tax return. Even better is that you could benefit from charitable contribution deductions. Many with higher MAGIs can also create a charitable remainder trust to reduce the NII.

Reduce your MAGI. You could also lower your net investment income tax by reducing your overall MAGI. Participation in deferred compensation plans and/or increasing contributions to qualified retirement plans or IRAs can help with this. 

However you decide to handle your NIIT, be sure to seek out the services of a qualified tax professional for assistance. There are many ins and outs when it comes to net investment income; that professional can help you understand the necessary steps that could reduce your tax burden.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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