02 September 2015
The Net Investment Income Tax (NIIT) has been in effect since 2013. It provides for an additional surtax on investment income for taxpayers with MAGI over a threshold specific to their tax filing status. I have found that most people do not understand the NIIT. Probably because it is new and because the IRS description is written like this:
For the Net Investment Income Tax, modified adjusted gross income is adjusted gross income (Form 1040, Line 37) increased by the difference between amounts excluded from gross income under section 911(a)(1) and the amount of any deductions (taken into account in computing adjusted gross income) or exclusions disallowed under section 911(d)(6) for amounts described in section 911(a)(1). In the case of taxpayers with income from controlled foreign corporations (CFCs) and passive foreign investment companies (PFICs), they may have additional adjustments to their AGI. See section 1.1411-10(e) of the final regulations.
Clear as mud.
Let me try to break this down to make it understandable. There are 4 elements to the NIIT:
- Statutory MAGI Thresholds
- Calculating your MAGI
- Definition of Net Investment Income
- Determining the lesser amount to be taxed
First let's look at the statutory MAGI thresholds:
|Federal Filing Status||MAGI Threshold Amount|
|MFJ and QW||$250,000|
|Single and HoH||$200,000|
If your MAGI is above the applicable threshold amount for your filing status, you will owe the Net Investment Income Tax on Net Investment Income. Note: these threshold amounts are not indexed for inflation, so each year more and more taxpayers will find themselves paying NIIT.
Calculating MAGI. MAGI for the NIIT is your AGI plus any amounts excluded as foreign earned income, income from controlled foreign corporations, or income from passive foreign investment companies. Most taxpayers do not have income from foreign sources, so in most cases the NIIT MAGI will just be the same as AGI.
Definition of Net Investment Income. Net Investment Income includes interest, dividends, capital gains, rental income, non-qualified annuities, trust income, and passive business income (i.e. limited partnerships). There are a few others listed on form 8960, but the sources of income listed above will cover 98% of taxpayers. If you have other forms of investment income you are probably sophisticated enough to know what they are and their impact on your NIIT.
Last, but not least, you have to determine which is the lesser amount - your Net Investment Income, or the amount by which you exceed your MAGI threshold. Let's look at a few scenarios.
Don is single and his only source of income is the rents he collects on the dozen houses he owns. He collected $93,000 in rental income in 2014. He had no adjustments to income. His MAGI for NIIT purposes is $93,000. This is below Don's statutory MAGI threshold. He does not owe NIIT.
Janice is single and earned $190,000 in salary in 2014. She also had interest income, capital gains, and dividends totaling $36,000. She had no adjustments to income. Her MAGI for NIIT purposes is $226,000. The threshold for her filing status is $200,000, which she exceeds by $26,000. We need to compare that amount ($26,000) to her Net Investment Income, which is $36,000. Janice will have to pay NIIT on the lesser of those two amounts - $26,000.
Thomas and Traci are married and file jointly. Thomas earned $140,000 in salary in 2014. Traci earned $155,000 in salary. They also has $1,600 in CD interest. They took a $2,500 adjustment for student loan interest paid. Their MAGI for NIIT purposes is $294,100 [$140,000 + $155,000 + $1,600 - $2,500]. They exceed the NIIT threshold for their filing status by $44,100. Their Net Investment Income was $1,600. They will owe NIIT on the lesser amount of $1,600.
Jeff is single. When his father passed he left Jeff a trust that generated $310,000 of income to Jeff in 2014. Jeff had no other sources of income and no adjustments to income. His MAGI exceeds the threshold for his filing status by $110,000. He has $310,000 of Net Investment Income. He will pay NIIT on the lesser amount of $110,000.
The Net Investment Income Tax is another reason to get as much of your investment portfolio as possible into tax-qualified accounts where it does not count as income. If you would like some advice on how to do that, come see me.