Created as part of the Health Care and Education Reconciliation Act to fund healthcare reform in 2010, the net investment income tax (NIIT) is a tax on net investment income. Those who are subject to the tax will pay 3.8 percent on the lesser of the two: their net investment income or the amount by which their modified adjusted gross income (MAGI) exceeds the threshold amount. The threshold amount for 2022 is $200,000 for single filers and $250,000 for married filing jointly.
Net investment income includes income from interest, dividends, capital gains, rental and royalty income, and non-qualified annuities. It also includes income from businesses involved in trading financial instruments or commodities. However, it does not include tax-exempt interest or distributions from qualified retirement plans.
One of the main triggers for the NIIT is capital gains tax. Long-term capital gains tax and short-term capital gains tax are both subject to the NIIT. The capital gains tax rate that applies to your gain depends on the type of asset, your taxable income, and how long you held the property. Short-term capital gains (assets held for one year or less) are taxed as ordinary income, while long-term capital gains (assets held for more than one year) are taxed at a lower rate.
Like other earnings and realized gains on investments, dividend income is taxable. The tax rate on dividends, however, is dependent on a number of factors including the type of dividend, the amount of the dividend, and the taxpayer's income. Qualified dividends, which are paid by domestic corporations and certain foreign corporations, are taxed at the same rate as long-term capital gains.
Congress hasn't made changes to rates on long-term capital gains and dividends for 2022 and 2023. That means the maximum federal tax rate on long-term capital gains and qualified dividends remains at 20 percent for taxpayers in the highest tax bracket. For taxpayers in the 10 percent and 15 percent tax brackets, the long-term capital gains tax rate is 0 percent.
For those subject to the NIIT, there are ways to reduce the amount of net investment income subject to the tax. One strategy is to sell losing investments to offset gains in other investments. Tax-loss harvesting involves selling investments at a loss to offset gains realized elsewhere in your portfolio. This can help reduce your taxable income and lower your net investment income subject to the NIIT.
Another strategy is to invest in tax-efficient funds. These funds are designed to minimize the amount of taxable income generated by the portfolio. They do this by investing in tax-free bonds, using tax-loss harvesting, and other strategies.
If you're subject to the NIIT, it's important to plan ahead to reduce the amount of net investment income subject to the tax. Working with a financial advisor or tax professional can help you identify opportunities to reduce your tax bill.
In other news, this week, the Bureau of Labor Statistics (BLS) released data showing that the consumer price index (CPI) rose 0.5 percent in January. This was higher than the 0.3 percent increase economists had predicted. The CPI measures the average change over time in the prices paid by urban consumers for a basket of goods and services. The increase in the CPI is a sign of inflationary pressure in the economy.
In the stock market, Stellus Capital Investment Corporation (NYSE:SCM) announced financial results for its fourth quarter and full year ended December 31, 2021. The company reported net investment income of $0.32 per share for the fourth quarter, exceeding analysts' expectations. The stock was up 2.5 percent in after-hours trading following the announcement.
Overall, the net investment income tax is an important consideration for investors in 2022. With careful planning and the right investment strategies, it's possible to minimize the amount of net investment income subject to the tax and reduce your tax bill.
