Net Investment Income Tax
How Net Investment Income Tax Works
The net investment income tax is a 3.8% surtax on a portion of your modified adjusted gross income (MAGI) over certain thresholds. It is generally paid by high earners with significant investment income.
The net investment income tax can still apply to your finances even if you manage to avoid paying significant income taxes on your investment income through the use of deductions, credits, and other tax perks.
Learn how it works and who must pay.
The Basics of Net Investment Income Tax
The net investment income tax thresholds are based on your filing status and income. You are likely subject to this tax if you have investment income and your modified adjusted gross income exceeds certain thresholds.
|Filing Status||Income Threshold|
|Single or head of household||$200,000|
|Married filing jointly||$250,000|
|Married filing separately||$125,000|
|Qualified widow(er) with a child||$250,000|
This tax is paid in addition to your income tax obligation. It's also over and above what you paid into Medicare through withholding from your earned income or estimated tax payments. But you're only subject to this tax if you have net investment income and your MAGI exceeds these thresholds.
Net investment income can be capital gains, interest, or dividends. It can include income produced by rental properties, capital gain distributions from mutual funds, and even royalty or annuity income and interest on loans you might have extended to others.
It includes the income derived from a trade or business that is classified as passive income and income from business trading financial instruments or commodities.
When a taxpayer sells pretty much any type of investment, they'll realize either a gain or a loss—they'll make money or they'll lose money if they sell for less than what they have invested in the asset. But there are some exceptions.
Tax-exempt interest is not included in net investment income. Gains realized from the sale of a personal residence are spared as well when the gain is excluded from income for income tax purposes. Gains on property held in a trade or business are also exempt.
Net investment income does not include wages, self-employment income, unemployment compensation, Social Security benefits, or alimony.
How the Net Investment Income Tax Developed
The net investment income tax was legislated as part of the Health Care and Education Reconciliation Act of 2010. It went into effect on January 1, 2013. Along with the Affordable Care Act, this Act reformed the health care market by requiring individuals to obtain health insurance or pay a tax penalty.
The net investment income tax was included as part of that legislation in order to raise revenue. The Joint Committee on Taxation estimated that together with the Additional Medicare Tax, the net investment income tax would generate billions in tax revenue in 2013, the first year that this surtax would be in effect.
Who Must Pay Net Investment Income Tax
The net investment income tax is imposed on estates and trusts as well as individuals.
For individuals, it applies to U.S. citizens and resident aliens. It does not apply to non-resident aliens unless they've elected to be treated as a resident of the U.S. for tax purposes so they can file joint married tax returns.
The net investment income tax applies to estates and trusts when their adjusted gross incomes for the year exceed the dollar amount at which the highest tax bracket begins.
Grantor trusts and trusts that are exempt from income taxes, such as charitable remainder trusts, are exempt from the net investment income tax. In most cases, taxes on grantor trusts are payable by the individual—the grantor—who formed and maintains them.
How to Calculate Net Investment Income Tax
Your IRS Form 1040 can help you calculate your net investment income tax.
First, calculate your MAGI. Start with your adjusted gross income—see line 11 of your Form 1040.
Second, add back certain deductions, including:
- the foreign earned income exclusion
- foreign housing costs
This number is your modified adjusted gross income for the purposes of net investment income tax, which may be slightly different from your MAGI for other tax calculations.
You can use the MAGI worksheet included on page 19 in the instructions for Form 8960 to calculate your MAGI for the net investment income tax.
Calculate Net Investment Income
If your net investment income is less than the portion of your MAGI over the tax thresholds, you would pay 3.8% of this amount instead. So now you have to compare your MAGI to your net investment income for the year.
Remember, this is net income. Trade commissions or fees are deducted from your realized amount of gain. You can subtract your expenses from your total realized gain, including costs you incurred to maintain these investments such as tax preparation fees.
Other deductions that can reduce net investment income include:
- Deductions related to producing rental and royalty income
- Deductions related to producing business income for a trade or business that is a passive activity or trades in financial instruments or commodities
- Penalty on early withdrawal of savings
- Investment interest expenses
- Miscellaneous investment expenses
- The portion of state income tax that relates to net investment income
- Casualty and theft losses related to property that was sold or disposed
Some of these deductions are already included in the investment income figures. For example, rental income, royalty income, business income, and net capital gains will already be a net amount after deductions or losses have been taken into account.
Other deductions, however, are not included in these net figures, so they must be deducted against investment income to arrive at net investment income. These separate deductions include the penalty on early withdrawal of savings, investment interest, investment expenses, state income tax allocated to investment income, and casualty and theft losses related to investment property.
Calculate Net Investment Income Tax
The net investment income tax is due on the lesser of your net investment income or the portion of your MAGI that exceeds the thresholds.
Multiply the lower number by 0.038. This is the amount of net investment income tax you will pay.
Where the Tax Revenue Goes
The official name of the net investment income tax is the "Unearned Income Medicare Contribution Tax."
This suggests that the tax revenue is used to fund Medicare, but the revenue raised by this tax actually goes into the nation's General Fund. In fact, you can be subject to the net investment income tax even if you're exempt from the Additional Medicare tax because these two taxes apply to different types of income.
How to Pay the Net Investment Income Tax
File IRS Form 8960 with your tax return if you're subject to the net investment income tax. The form comes complete with instructions to help you determine what you owe, and it should be used by both individuals and estates and trusts.
Keep in mind that if you owe this tax, you will need to make quarterly estimated payments on the amount you think you'll owe in addition to any quarterly income payments.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.