First enacted in 2013 to raise revenue for the Affordable Care Act, the Net Investment Income Tax (NIIT) introduced a 3.8% tax on net income from certain investments. This tax affects estates, trusts, and individuals with Modified Adjusted Gross Income (MAGI) over a certain threshold. Meaning that if you have yearly net income from rental, royalty income, dividends, capital gains, or funds generated from other non-wage activities that exceed that threshold, you may be subject to Net Investment Income Tax.
The line has historically been about $200,000 for individuals, $250,000 for married couples filing jointly, and about $12,950 for trusts or estates. Remember that this could always change as tax laws change.
NIIT does not usually apply to self-employment income or to the money generated from the sale of a personal residence.
It is also important to note that while NIIT is connected to the ACA, it is separate from the 0.9% tax collected for Medicare. That tax comes out of your wages.
Net Investment Income Tax and Your NII
First, it’s important to understand the components that go into NIIT. The biggest contributing factor is your Net Investment Income or NII. This portion of your income is based on passive earnings from activities such as rental property income, stocks and bonds, and other investments.
It doesn’t include income like wages, social security benefits, death benefit payouts, alimony, tax-exempt interest income, income from certain qualified retirement plan distributions, income subject to self-employment taxes, or unemployment pay.
This alone is not used to determine whether or not you pay NIIT. In order to calculate that, we’ll need to figure out your Modified Adjusted Gross Income (or MAGI). Note that all calculations are based on the NII you receive before taxes.
Net Investment Income Tax and Your MAGI
Your MAGI is calculated using your NII, as well as all over taxable income for your household. This is the magic number determining whether you will need to pay Net Investment Income Tax. MAGI essentially comprises all taxable income for your entire household, including your wages and your NII. If those numbers combined push you over the $200,000-$250,000 marker for the tax year, then that is the point at which you will need to pay that 3.8% tax.
NIIT is Paid on The Lesser of Two Values
That may seem steep, but there are some factors that help mitigate it. For instance, you do not pay NIIT on your entire income for the year, or even necessarily your entire NII. You only pay taxes on the portion that exceeds your cutoff OR your NII, whichever one is smaller. This grants a significant boon to people that have investments as a large portion of their income up to that threshold.
For example, let’s say you are single and make $190,000 in wages and $20,000 of NII. In the end, you are only paying NIIT on $10,000 of your total $210,000 income for the year. Since that number is less than your NII of $20,000, you would need to pay the 3.8% tax on the amount of money exceeding the $200,000 threshold. In this case, $10,000.
If you already make $200,000 a year, then there’s a good chance you will end up paying the 3.8% tax on the entirety of your NII.
MAGI Thresholds
Your marital status is the primary factor determining your NIIT threshold.
If you are:
- Single, your threshold is $200,000.
- Married, your threshold is $250,000.
- Married and filing separately, your threshold is $125,000.
- In all other cases, it is $200,000.
ACA Marketplace
It’s natural to wonder what taxes go towards supporting, and it’s not always easy to see where tax dollars go. NIIT has a clearer path than most since it is a part of the Affordable Care Act, which brought healthcare reforms. About 23 million Americans are currently covered under the ACA.
In Conclusion
Unless you make a certain amount a year and your investments have been very successful, you likely won’t need to worry about Net Investment Income Tax at all. The occasional windfalls you are most likely to receive, such as personal property sales, are not included. There are things you can do to mitigate the impact that the NIIT has on your tax season. But if you are in the position to worry about it, we recommend you work with a CPA or other tax professional to find good strategies for minimizing the money you need to pay at the end of the year.
