With the introduction of the Affordable Care Act (ACA or ObamaCare), come many new types of taxation that high earning taxpayers must be aware about. Starting in 2013, high-income taxpayers will face a 3.8% additional Medicare contribution tax on net investment income (the net investment income tax or NIIT). It is important to remember this when filing taxes and making tax planning investment decisions.
What is the 3.8% Tax on Net Investment Income?
The net investment income tax NIIT is an extra tax that is imposed in addition to your regular income tax. Taxpayers are subject to the NIIT only if their modified adjusted gross income (MAGI) exceeds $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, $200,000 for unmarried taxpayers and heads of household. The amount actually subject to the tax is the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold. Thus, this tax is of particular concern to taxpayers who have large amounts of investment income.
Who owes the 3.8% Tax on Net Investment Income?
Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:
|Married filing jointly||
|Married filing separately||
|Head of household (with qualifying person)||
|Qualifying widow(er) with dependent child||
Taxpayers should be aware that these threshold amounts are not indexed for inflation.
Types of income and gain subject to the 3.8% NIIT:
There are three categories of NII. These three categories cast a wide net over many types of income, including income from interest, dividends, royalties, along with income from a passive trade or business and income attributable to an investment of working capital.
Below is a summary of the type of income subject to the 3.8% net investment tax:
- gross income from interest, dividends, annuities, royalties, and rents, unless those items were derived in the ordinary course of an active trade or business;
- other gross income from passive activities; and
- taxable net gain from dispositions of property other than property held in an active trade or business.
Every individual’s potential liability for the NII tax is unique and no one formula or strategy exists to plan for the NII.
Income and Gain Exempt from 3.8% NIIT
- Any item that is excluded from income for income tax purposes is likewise excluded from the NIIT.
- This means that tax-exempt interest and the excluded gain from the sale of your main home aren’t subject to the tax.
- Distributions from qualified retirement plans, including individual retirement accounts (IRAs) and Roth IRAs, aren’t subject to the NIIT. Wages and self-employment income aren’t subject to the NIIT, though they may be subject to a different Medicare surtax that affects high earning individuals as well. When Congress created the NII tax, it specifically made an exception for certain types of retirement income. This exclusion applies to qualified retirement plans and annuity plans, tax-sheltered annuities, traditional and Roth IRAs, and deferred compensation plans under Code Sec. 457(b) plan.
Notes about Net Investment Income Tax
It appears that net rental income from a self-rental situation will be subject to the NIIT. A self-rental occurs when property that you own is rented for use in a trade or business activity in which you materially participate. If this is the case, the net rental activity income for the year from that property is treated as nonpassive income, even though rental income is generally passive. Despite this, the income is still subject to the NIIT, because rents are considered investment income even though the income is nonpassive.
3.8 Percent Medicare Contribution Tax on Net Investment Income
There are significant planning opportunities that should be considered to avoid the 3.8% Medicare Contribution tax on net investment income. Taxpayers who might be affected by this should contact attorneys or accountants to learn about ways to significantly limit their exposure to the NIIT. You can find additional information about the NIIT in the 2013 final regulations and in a new 2013 proposed regulation published on Dec. 2, 2013.
Although you may have heard that the NII tax only impacts higher-income individuals, this is not completely accurate. Married couples with two incomes need to be aware of the NII tax. Additionally, these threshold amounts are not annually indexed for inflation; over time, inflation will bring more individuals within the reach of the NII tax over time.
IRS Documents on Net Investment Income Tax
See Form 8960 , Tax Net Investment Income (in to see if this tax applies to you. You can view form instructions for details on how to calculate the tax. If you owe tax, you must file Form 8960 with your federal tax. If you had little withholding taxes or did not pay enougg estimated tax , you may have to pay a penalty payment of estimated tax . The amounts of Net Investment Income that are included on your Form 1040 by reason of Form 8814 are included in calculating your Net Investment Income. However, the calculation of your Net Investment Income does not include (a) amounts excluded from your Form 1040 due to the threshold amounts on Form 8814 and (b) amounts attributable to Alaska Permanent Fund Dividends.