What is the Net Investment Income Tax (NIIT)?

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.

What types of income are included in NIIT?

The Net Investment Income Tax (NIIT) 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.

What types of income are included in NIIT?

In general, investment income includes but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer (within the meaning of section 469).

To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items considered in computing Net Investment Income:

  • Gains from the sale of stocks, bonds and mutual funds.

  • Capital gain distributions from mutual funds.

  • Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence).

  • Gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).

What types of income are excluded from NIIT?

Wages, unemployment compensation, operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income and distributions from certain Qualified Plans are not part of the NIIT calculation

Who Owes the NIIT?

Married individuals filing a joint return will owe the tax if they have Net Investment Income and have modified adjusted gross income (MAGI) over $250,000. For those filing as single or Head of a Household, the NIIT will apply if their MAGI is over $200,000.

What Tax Strategies are available for dealing with Net Investment Income Tax?

The easiest way to deal with Net Investment Income Tax is to look at harvesting tax losses by selling off investments that you own on which you’ve currently lost money. That’s generally a good idea even under the regular income tax, because capital losses are fully deductible against capital gains and can also offset up to $3,000 of other types of income. For net investment income tax purposes the same is true, and capital losses can reduce the amount of NIIT you pay.

You can also try to keep your overall income below the threshold limits at which the NIIT gets imposed. That’s usually more difficult, but steps like delaying taking withdrawals from traditional IRA or 401(k) accounts or deferring income you expect late in the year until early next year could keep your income down, thereby helping you avoid the tax.

You can also use some of the following strategies:

  • Donate appreciated securities instead of cash to IRS-approved charities so that gains won’t be included on your return even though you will receive a tax deduction for the donation.

  • Use installment sales or Section 1031 like-kind exchanges to either spread the gain recognition over several years or defer the gain on the sale of property. These two strategies work best for investment real estate.

As you can see, higher income taxpayers with investment income have some planning options when it comes to limiting the impact of the NIIT. However, in many cases, there may not be a way to avoid it.

The NIIT is complex and all strategies should be discussed with your tax and investment advisors before implementation to avoid other unintended tax consequences.

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