What is Net Investment Income Tax?
Despite its name, the Tax Cuts and Jobs Act (TCJA) did not cut all types of taxes. It left several taxes unchanged, including the 3.8% tax on net investment income (NII) of high-income taxpayers.
You are potentially liable for the net investment income tax if your modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for joint filers and qualifying widows or widowers; $125,000 for married taxpayers filing separately). Generally, MAGI is the same as adjusted gross income but may be higher with foreign earned income and certain foreign investments.
Calculating The Net Investment Income Tax
To calculate net investment income tax, multiply 3.8% by the lesser of 1) your NII, or 2) the amount by which your MAGI exceeds the threshold. For example, if you are single with $250,000 in MAGI and $75,000 in NII, your tax would be 3.8% × $50,000 ($250,000 – $200,000), or $1,900.
NII generally includes net income from taxable interest, dividends, capital gains, rents, royalties, and passive business activities, among other sources. Several types of income are excluded from NII, including wages, retirement plan distributions, Social Security benefits, and most non-passive business income. Also excluded is the nontaxable gain on the sale of a personal residence.
Strategies to Reduce Net Investment Income Tax
Given the way the net investment income tax is calculated, you can reduce the tax either by reducing your MAGI or reducing your NII. To accomplish the former, you could maximize contributions to IRAs and qualified retirement plans. To do the latter, you might invest in tax-exempt municipal bonds or in growth stocks that pay little or no dividends.
There are many strategies for reducing the net investment income tax, but, while tax reduction is important, it is not the only factor in prudent investment decision-making. You can learn more about year-end tax planning by year on our collection of accounting and finance articles.
Please contact one of our experienced tax advisors for personalized assistance in understanding your net investment income tax threshold.