By Chris Varjabedian, Woodland Hills, Calif.
Editor: Mark G. Cook, CPA, MBA, CGMA
The net investment income tax imposed by Sec. 1411 is a 3.8% tax on the lesser of (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount, which is discussed later. Under Sec. 1411(d), MAGI is defined as adjusted gross income increased by the amount excluded from gross income under Sec. 911(a)(1) (the foreign earned income exclusion) over the amount of deductions or exclusions disallowed under Sec. 911(d)(6) (denial of a double tax benefit from excluded foreign earned income). The net investment income tax went into effect for tax years beginning on or after Jan. 1, 2013, and is more likely to affect wealthier individuals, but can also affect individuals of more moderate means who have a spike in income in a particular year.
Investment income for purposes of the net investment income tax includes:
- Annuity distributions;
- Dividends;
- Income from passive activities;
- Interest and net gain, to the extent taken into account in computing taxable income, from the disposition of property other than property held in a trade or business to which the net investment income tax does not apply;
- Rents; and
- Royalties.
Income such as salaries and wages, IRA distributions, self-employment income, gain on sale of an active interest in a partnership or S corporation, capital gains from the sale of a principal residence excluded under Sec. 121, tax-exempt interest, and veterans benefits are excluded.
As noted above, the net investment income tax applies to an individual taxpayer only when the taxpayer's MAGI exceeds a threshold amount. The thresholds for each type of affected taxpayer are as follows:
- Single: $200,000;
- Married filing jointly: $250,000; and
- Married filing separately: $125,000.
Other Ways to Minimize Net Investment Income Tax
Taxpayers can avoid the net investment income tax by avoiding income that is subject to the tax and by keeping their MAGI below the applicable threshold amount. Ways to achieve these goals include:
Roth IRA conversions: Withdrawals from Roth IRAs, unlike withdrawals from traditional IRAs and qualified plans, are not includible in MAGI for purposes of the net investment income tax, so a withdrawal from a Roth IRA will not cause other income to be subject to the tax. However, the deemed distribution in the year of conversion is included in MAGI, so a taxpayer may want to do conversions over a number of years to avoid having the conversion trigger the tax.
Installment sales: Deferring gains by spreading the proceeds through installments will defer application of the 3.8% tax on the gains or possibly avoid the tax by keeping MAGI under the threshold in any year.
Charitable contributions: By donating appreciated securities held more than one year to approved charities, taxpayers may avoid tax on any related gains while still benefiting from the deduction.
Municipal bonds: These will reduce both net investment income tax and MAGI.
Tax-deferred annuities: Earnings from this type of annuity are not taxed until withdrawn.
Life insurance: Paid-out death benefits are generally exempt from the 3.8% tax because they are excluded from gross income.
Rental real estate: Income can be offset by depreciation deductions.
Oil and gas investments: Income from oil and gas investments can be offset by deductions for intangible drilling costs and depletion.
The net investment income tax, targeted primarily toward the wealthy, is an additional tax on top of regular tax liability. Fortunately, proper planning and the assistance of a tax professional may allow this tax to be deferred, reduced, or, in some cases, avoided completely.
EditorNotes
Mark Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.
FAQs
Income from investments
The income you receive from interest and unqualified dividends are generally taxed at your ordinary income tax rate. Certain dividends, on the other hand, can receive special tax treatment, which are usually taxed at lower long-term capital gains tax rates.
How do I avoid 3.8% investment tax? ›
Sell investments at a loss to offset investment gains. Defer capital gain, such as selling the investment in the future instead of selling it now. Use Section 1031 like-kind exchange which is selling an investment property and using that money to buy another investment property.
What is the net income investment tax? ›
Basics of the Net Investment Income Tax
The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.
Is the net investment income tax still in effect? ›
The NIIT is set at 3.8% for the 2023 tax year. To give some background, the net investment income tax is part of the Health Care and Education Reconciliation Act of 2010. While the NIIT might seem out of place here, it was actually created to help fund the aforementioned healthcare reforms.
How do you calculate net investment income tax? ›
Net investment income is calculated by adding up all of the income you earned from investments in the past tax year and subtracting any related expenses.
How do investment losses affect taxes? ›
You can't simply write off losses because the stock is worth less than when you bought it. You can deduct your loss against capital gains. Any taxable capital gain – an investment gain – realized in that tax year can be offset with a capital loss from that year or one carried forward from a prior year.
How can I reduce my NIIT tax? ›
Strategies to Reduce Your Modified Adjusted Gross Income:
- Invest more taxable investment funds in municipal bonds. ...
- Invest taxable investment funds in growth stocks. ...
- Consider conversion of traditional IRA accounts to ROTH accounts. ...
- Invest in life insurance and tax-deferred annuity products. ...
- Invest in rental real estate.
As an investor, you may owe an additional 3.8% tax called net investment income tax (NIIT). But you'll only owe it if you have investment income and your modified adjusted gross income (MAGI) goes over a certain amount.
Who is subject to 3.8% investment tax? ›
The NIIT is equal to 3.8% of the net investment income of individuals, estates, and certain trusts. Net investment income includes interest, dividends, annuities, royalties, certain rents, and certain other passive business income not subject to the corporate tax.
What is net investment income for 3.8% tax? ›
Net investment income is income received from assets (before taxes) including bonds, stocks, mutual funds, loans, and other investments (less related expenses). NII is subject to a 3.8% tax for individuals with an NII and MAGI above certain thresholds.
The NIIT applies to income from a trade or business that is (1) a passive activity, as determined under § 469, of the taxpayer; or (2) trading in financial instruments or commodities, as determined under § 475(e)(2). The NIIT does not apply to wages, unemployment compensation, or income from a nonpassive business.
What is the NIIT threshold for 2023? ›
Net Investment Income Tax (NIIT): The 3.8% NIIT applies when MAGI exceeds a threshold, with the tax calculated on the lesser of net investment income or the amount by which MAGI exceeds the threshold. The thresholds are: MFJ – $250,000, single or HOH – $200,000, and MFS – $125,000.
Does everyone pay net investment income tax? ›
Not everyone will need to pay the NIIT, and only those who fall above certain income thresholds will be subject to it. The IRS statutory income thresholds are as follows: Married filing jointly — $250,000. Married filing separately — $125,000.
Was the net investment income tax repealed? ›
While many tax changes were enacted as part of the 2018 Tax Cuts & Jobs Act (TCJA), repeal or lessening of the Net Investment Income Tax was not part of it. Thus, the Net Investment Income Tax is still a burden for taxpayers to whom the Act applies, and a proper understanding of the law is important.
Does investment reduce tax? ›
Shoot for Long-Term Capital Gains
Investing can be an important tool in growing wealth. An additional benefit of investing in stocks, mutual funds, bonds, and real estate is the favorable tax treatment for long-term capital gains.
Do you pay taxes on investment income? ›
In many cases, you won't owe taxes on earnings until you take the money out of the account—or, depending on the type of account, ever. But for general investing accounts, taxes are due at the time you earn the money. The tax rate you pay on your investment income depends on how you earn the money.
Is investment income taxed for tax purposes? ›
Most investment income is taxable. But your exact tax rate will depend on several factors, including your tax bracket, the type of investment, and (with capital assets, like stocks or property) how long you own them before selling.
Do I have to report investment income? ›
While all capital gains are taxable and must be reported on your tax return, only capital losses on investment or business property are deductible.
Is investment income taxed the same as earned income? ›
Investment income is the profit earned from investments such as real estate and stock sales. Dividends from bonds also are investment income. Investment income is taxed at a different rate than earned income. The profits from the sale of gold coins or fine wine could be considered investment income.
