Beginning in 2013, a 3.8% tax applies to all or a portion of the net investment income of certain individuals, estates, and trusts. This net investment income tax (NIIT) is not withheld from a taxpayer’s unearned income. Instead the additional tax is calculated on Form 8960 (Net Investment Income Tax-Individuals, Estates, and Trusts) and reported on Form 1040 (for individuals) or Form 1041 (for estates and trusts).
The 3.8% NIIT does not apply to the investment earnings of corporations or limited liability companies (LLCs) treated as corporations. However, it may apply to dividend, interest, or other payments such entities make to individuals, estates, or trusts. The NIIT should be considered when calculating estimated taxes and/or withholding allowances. Taxes, including the NIIT, not paid during the year may be subject to an underpayment penalty. The NIIT is in addition to the 0.9% Medicare taxes on earned income that is applicable to individuals with earned income over certain thresholds. Therefore, certain taxpayers may owe both taxes.
Individuals with modified adjusted gross income (MAGI) over $200,000 ($250,000 for married filing joint or a surviving spouse; $125,000 for married filing separately) must pay the 3. 8% NIIT on the lesser of
- net investment income (see paragraph 605.26), or
- MAGI (see paragraph 605.14) over $200,000 ($250,000 for married filing joint or a surviving spouse; $125,000 for married filing separately).
Estates and trusts must pay the NIIT on the lesser of
- undistributed net investment income, or
- the excess of adjusted gross income (AGI) over the amount at which the highest estate and trust income tax bracket begins ($11,950 for years beginning in 2013).
Estates and trusts are subject to the tax at relatively low income levels, unless net investment income is distributed. It may be beneficial for income tax purposes to distribute sufficient income to the beneficiaries rather than accumulate income that would generate the additional tax for the estate or trust. If beneficiaries are not subject to the additional tax, the tax savings could be substantial.
For purposes of the NIIT, net investment income
- Gross income from interest, dividends, annuities, royalties, and rents; less properly allocable deductions.
Note: Interest, dividends, annuities, royalties, and rents derived in the ordinary course of a trade or business (that is not a trade or business described in item b. or c.) are not subject to the tax.
- Gross income from a trade or business that is a passive activity, less properly allocable deductions.
- Gross income from a trade or business of trading in financial instruments or commodities, less properly allocable deductions.
- Net gain (to the extent taken into account in computing taxable income) from the disposition of nonbusiness property (e.g., capital gain from selling shares of stock) or the disposition of property held in a trade or business that is a passive activity or a trade or business of trading in financial instruments or commodities, less properly allocable deductions.
- Any income, gain, or loss attributable to an investment of working capital
The IRS has also issued a set of frequently asked questions (FAQs), available at www.irs.gov , regarding the NIIT. (Search for “Net Investment Income Tax” to find these FAQs.) While the FAQs are not authoritative guidance, they do provide insight into how the Service administers the NIIT and are mentioned throughout this section.