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 3.8% tax on certain types of investment income. The tax is levied on individuals, estates, and trusts that meet certain income thresholds. While the NIIT has been in effect for over a decade, many investors still have questions about how it works and how it affects their portfolios. In this article, we'll provide an overview of the NIIT and offer some tips for minimizing its impact.
What is 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 certain thresholds. For individuals, the threshold is $200,000 for single filers and $250,000 for married couples filing jointly. Estates and trusts are subject to the tax on the amount of undistributed net investment income that exceeds a certain threshold.
What types of income are subject to the NIIT?
The NIIT applies to several types of investment income, including:
- Interest and dividends
- Capital gains (both long-term and short-term)
- Rental and royalty income
- Non-qualified annuity income
- Income from passive activities such as limited partnerships and rental real estate
Not all investment income is subject to the NIIT, however. For example, income from tax-exempt municipal bonds is not included in net investment income.
How is the tax calculated?
The NIIT is calculated on Form 8960, which is filed with an individual's income tax return. The tax is based on the lesser of net investment income or the amount by which MAGI exceeds the threshold. For example, if an individual has $50,000 in net investment income and a MAGI of $275,000, the tax would be calculated on $25,000 ($275,000 - $250,000). The tax would be 3.8% of $25,000, or $950.
How can investors minimize the impact of the NIIT?
Like other earnings and realized gains on investments, dividend income is taxable. The tax rate on dividends, however, is dependent on a taxpayer's income. Those in lower tax brackets may pay little or no tax on dividends. By investing in tax-efficient dividend-paying stocks, investors can reduce the impact of the NIIT.
Another strategy for minimizing the impact of the NIIT is to harvest capital losses. By selling losing positions, investors can offset gains and reduce their net investment income. This can be particularly effect in years when gains are higher than usual.
What closed-end funds have reported sources of distribution for March and this fiscal year to date?
BOSTON, April 03, 2023--The following closed-end funds reported sources of distribution for March and this fiscal year to date.
- XYZ Fund: $0.50 per share for March, $1.50 per share year-to-date
- ABC Fund: $0.40 per share for March, $1.25 per share year-to-date
- DEF Fund: $0.60 per share for March, $1.75 per share year-to-date
How does the NIIT affect capital gains taxes?
Long-term capital gains tax and short-term capital gains tax, capital gains tax triggers, how each is calculated & how to cut your tax bill.
The NIIT can affect both long-term and short-term capital gains taxes. Long-term capital gains are typically taxed at a lower rate than short-term gains. However, if an investor's net investment income exceeds the threshold, they will be subject to the 3.8% NIIT on their long-term gains. This can increase the effect tax rate on long-term gains.
One way to reduce the impact of the NIIT on capital gains taxes is to hold investments for longer periods of time. By holding investments for at least a year and a day, investors can qualify for the lower long-term capital gains tax rate and reduce their exposure to the NIIT.
What should investors be aware of when it comes to tax rules?
Tax rules have generally remained unchanged, which is a good thing given rates are historically low. However, even though the tax rules haven't changed, investors should still be aware of how they can minimize their tax burden. This includes harvesting tax losses, investing in tax-efficient funds, and taking advantage of retirement accounts.
What is the Taxpayer Advocate Service?
Every year the Taxpayer Advocate Service (TAS) helps thousands of people with tax problems. This success story is only one of many examples of how the TAS can assist taxpayers who are struggling with IRS issues. If you're having trouble resolving a tax issue, consider reaching out to the TAS for help.
