You might be subject to the Net Income Tax (NIIT) if you have significant investment income and earn a high-income income.
The Net Investment Income tax is a 3.8% surtax. It applies to investment income whose modified adjusted gross income is higher than a threshold. This tax is applicable to both individuals and estates and trusts. It has been in effect since 2013. You may have to pay the NIIT if you are in a high-capital gains tax bracket.

Our guide will answer all your questions about whether you have to pay NIIT or how to file taxes.

If you make income from investing, you are creating net investment income (NII). You can also create NII if your landlord earns rental income. The IRS defines net investment income as sources such as:

• Capital gains
• Dividends
• Non-qualified annuities
• Rent and royalty income
• Interest subject to tax

Passive income earned from a business can also be considered net investment income. Wages, Social Security Benefits and unemployment pay are not considered net investment income. Alimony, alimony, and other forms of self-employment income are also not included.

Let's take, for example, the $15,000 profit you made selling Tesla stock in this year. Let's say you made $500 in taxable income and $1,000 in dividend income in the past year. This amounts to $16,500 in investment income. You also paid $250 in brokerage fees. This reduces your annual net investment income to $16,250

What is the Net Investment Income Tax (NIIT), and how can it be calculated?

The 2010 Health Care and Education Reconciliation Act included the Net Investment Income Tax. It went into effect in 2013. The purpose of NIIT was to finance the various reforms.

NIIT charges a 3.8% tax, but this only applies if your net investment income exceeds the threshold for your filing status. These are the current tax thresholds for net investment income as set out by the IRS.

U.S. citizens, resident aliens and those with net investment income exceeding these thresholds will be required to pay NIIT. Non-resident aliens are exempt from this tax unless they marry an American citizen or U.S.-residing spouse, and then file taxes together.

If they have undistributed net investments income plus adjusted gross income above the dollar amount at the top of the estate or trust tax bracket for the year, trusts and estates must pay net investment income tax

How is the NIIT calculated?

The NIIT tax rate for 2018 is 3.8%. This percentage does not apply to the less portion of your net investment income, or to the MAGI above the threshold for filing status.

• Your net investment income
• Your MAGI
• The NIIT MAGI threshold to determine your filing status

To calculate your net investment income, you must first calculate your gross investment income, then subtract eligible deductions such as tax preparation costs, brokerage costs, state income taxes, or even running your rental properties.

To calculate your modified adjusted gross, first you need to calculate your adjusted Gross Income (AGI). You will need to calculate your gross income. This includes income sources such as wages, dividends, capital gain, and business income. Also, you subtract income adjustments like student loan interest or alimony payments. For more information about how to calculate AGI, refer to the 1040 instructions.

Once you have your AGI, calculate your MAGI. This is your adjusted gross income after any deductions or tax credits. For some investors, AGI is the same as MAGI. Healthcare.gov offers a helpful guide to help you estimate your MAGI.

Examples of the NIIT

Once you have calculated your NII, MAGI, and other factors, you can determine the amount subject to the 3.8% net income tax. You only pay 3.8% on net investment income less your filing threshold.

Let's assume that two filers have exactly the same MAGI of $260,000. However, the first filer has Net investment income of $20,000 and the second filer has net investment income of $100,000. Let's say that two filers have the exact same MAGI of $260,000, but the first filer has Net Investment Income of $20,000 while second filer has Net Investment Income of $100,000.

As you can see, these two scenarios are quite different. You pay 3.8% tax for your $20,000 in NII because it is less than the $60,000 you exceed the MAGI threshold. In scenario 2, however, you pay 3.8% on the $60,000 excess MAGI because it is less than your $100,000 of the NII.

How do you report the net investment income tax?

The Form 8960 allows you to calculate your net investment income tax. You must pay NIIT if filing as an individual or estate. Form 1040 is for individuals. Form 1041 is for trusts and estates.

A certified public accountant (CPA) can help you file your taxes, especially if this is your first time paying NIIT.

The IRS states that NIIT is subjected to the estimated tax provisions. If you believe you will be subject to NIIT, you should estimate it in order to adjust your income tax withholdings and estimated payments so that you don't underpay.

Is there a way to avoid paying the NIIT?

Two main methods to reduce or avoid net investment income taxes are to lower your net income (NII), and to increase your MAGI.

You have many options to reduce your tax liability. You can start by contributing to an IRA and 401(k) to reduce your taxable income. You can also contribute to a HSA or FSA, which are viable options. Self-employed people can also reduce their taxable income by deferring income and taking business expense deductions.

There are many options available to you when it comes to lowering your net investment earnings. First, keep good records so that you can claim brokerage fees and other tax deductions. Tax-loss harvesting can be used to offset capital gains.

The bottom line is that NIIT will be paid by very wealthy individuals. You can lower the amount you pay by using tax preparation and bookkeeping tips.

Last Thoughts

You can file taxes by yourself, or use popular tax software such as TurboTax and H&R Block if you are required to pay Net Investment Income. For one-on-one assistance, you can consult a CFP or CFP.