If you have income from investments, such as interest, dividends, capital gains, or rental income, you may be subject to the net investment income tax (NIIT). The NIIT is a 3.8% tax that applies to certain net investment income of individuals, estates, and trusts that have income above certain threshold amounts. In this article, we will explain what the NIIT is, how it works, who owes it, how to calculate it, and how to report and pay it.
What is the Net Investment Income Tax?
The NIIT is a 3.8% tax that applies to the lesser of:
- Your net investment income, or
- The amount by which your modified adjusted gross income (MAGI) exceeds the threshold amount for your filing status.
Net investment income is the total amount of income you receive from your investments, such as interest, dividends, capital gains, rental income, royalty income, and non-qualified annuities, minus any related expenses, such as interest expense, investment fees, or depreciation.
Modified adjusted gross income is your adjusted gross income (AGI) plus any foreign earned income exclusion or foreign housing exclusion or deduction that you claim on your tax return.
The threshold amounts for the NIIT are:
- Married filing jointly – $250,000
- Married filing separately – $125,000
- Single or head of household – $200,000
- Qualifying widow(er) with a dependent child – $250,000
These threshold amounts are not indexed for inflation and remain the same every year.
Who Owes the Net Investment Income Tax?
You will owe the NIIT if you have net investment income and your MAGI exceeds the threshold amount for your filing status. For example, if you are single and have $100,000 of net investment income and $300,000 of MAGI in 2021, you will owe the NIIT on $100,000 (the lesser of your net investment income or the amount by which your MAGI exceeds $200,000).
However, if you do not have any net investment income or your MAGI is below the threshold amount for your filing status, you will not owe the NIIT. For example, if you are married filing jointly and have $50,000 of net investment income and $200,000 of MAGI in 2021, you will not owe the NIIT because your MAGI does not exceed $250,000.
The NIIT applies to U.S. citizens and residents as well as nonresident aliens who elect to be treated as residents for tax purposes. However, it does not apply to nonresident aliens who do not make such an election.
How to Calculate the Net Investment Income Tax
To calculate the NIIT, you need to determine your net investment income and your MAGI and compare them with the threshold amount for your filing status. You can use Form 8960 to figure out the amount that you owe.
Here are the steps to calculate the NIIT:
- Step 1: Calculate your net investment income by adding up all your gross income from investments and subtracting any related expenses. You can use Part I of Form 8960 to do this.
- Step 2: Calculate your MAGI by adding back any foreign earned income exclusion or foreign housing exclusion or deduction that you claim on your tax return to your AGI. You can use Part II of Form 8960 to do this.
- Step 3: Compare your net investment income and your MAGI with the threshold amount for your filing status. If both are below the threshold amount, you do not owe any NIIT. If either one is above the threshold amount, use Part III of Form 8960 to calculate the amount of NIIT that you owe by multiplying 3.8% by the lesser of your net investment income or the excess of your MAGI over the threshold amount.
For example, suppose you are single and have $100,000 of net investment income and $300,000 of MAGI in 2021. Your threshold amount is $200,000. You will owe NIIT on $100,000 (the lesser of your net investment income or the excess of your MAGI over $200,000). Your NIIT will be $3,800 ($100,000 x 3.8%).
How to Report and Pay the Net Investment Income Tax?
You must report and pay the NIIT on your federal income tax return for the year in which you have net investment income and MAGI above the threshold amount. You must attach Form 8960 to your tax return and enter the amount of NIIT on Schedule 2, line 9.
You must also pay estimated tax on the NIIT if you expect to owe more than $1,000 in total tax for the year, including the NIIT. You can use Form 1040-ES to calculate and pay your estimated tax. You can also adjust your withholding from your wages or other income to cover the NIIT.
If you do not pay enough tax during the year, either through withholding or estimated tax, you may be subject to an underpayment penalty. You can use Form 2210 to see if you owe a penalty and how to avoid it in the future.
How to Reduce or Avoid the Net Investment Income Tax
There are some strategies that you can use to reduce or avoid the NIIT, such as:
- Reducing your net investment income by increasing your investment expenses, such as interest expense, investment fees, or depreciation.
- Reducing your MAGI by increasing your deductions, such as contributions to retirement plans, health savings accounts, or charitable donations.
- Deferring or avoiding capital gains by holding your investments for more than one year, using tax-loss harvesting, or using 1031 exchanges.
- Excluding or reducing certain income from net investment income, such as income from an active trade or business, income from a qualified retirement plan, or income from a qualified opportunity fund.
- Choosing investments that generate tax-exempt or tax-deferred income, such as municipal bonds, Roth IRAs, or annuities.
However, before you implement any of these strategies, you should consult with a tax professional who can help you evaluate the pros and cons of each option and advise you on the best course of action for your situation.
That is where we come in.
Quilca CPA Group Can Help You with Your Taxes
If you are subject to the NIIT or want to learn more about it, you should contact us. We specialize in tax preparation and planning for individuals and businesses, and we have the expertise and experience to help you with all aspects of your NIIT. We will work with you to understand your financial goals and challenges and provide you with customized solutions that fit your needs.
If you are ready to get professional help with your taxes, contact us today at (786) 310-5582 or [email protected] to schedule an initial consultation. We look forward to hearing from you!
