How Is the Net Investment Income Tax (NIIT) Calculated?
Understand the mechanics of the Net Investment Income Tax. This guide clarifies how your total income and specific investment gains interact to determine your final tax base.
The Net Investment Income Tax (NIIT) is a 3.8% surtax on certain investment income for taxpayers whose income surpasses specific thresholds. Enacted under Internal Revenue Code Section 1411, this tax operates separately from the regular income tax system. It targets income from investments rather than from labor, such as wages or self-employment earnings. The NIIT applies only if you have qualifying investment income and your income is above a set amount.
Determining if NIIT Applies to You
The first step is to compare your Modified Adjusted Gross Income (MAGI) to thresholds based on your filing status. For most individuals, MAGI is the same as their Adjusted Gross Income (AGI) found on their tax return.
You are potentially subject to the NIIT only if your MAGI exceeds these specific amounts. For those who are Married Filing Jointly or a Qualifying Surviving Spouse, the threshold is $250,000. For Single individuals and those filing as Head of Household, the threshold is $200,000. The threshold for a Married Filing Separately status is $125,000. If your MAGI is below the applicable threshold for your filing status, you are not liable for the NIIT.
Identifying Your Net Investment Income
Investment Income Included in NII
To calculate the NIIT, you must identify your gross income from various investment sources. This includes common items like interest and dividends, and capital gains from selling assets like stocks, bonds, and real estate. This figure is calculated on Schedule D of your tax return. Income from rental properties, reported on Schedule E, and royalty income are also included. The category also captures income from business activities in which you do not materially participate, known as passive activities.
Income Specifically Excluded from NII
Certain types of income are explicitly excluded from net investment income. Wages, salaries, and bonuses you earn from employment are not considered investment income. Income from a trade or business in which you are an active participant also falls outside the scope of the NIIT. Distributions from most retirement accounts, such as 401(k)s and traditional IRAs, are not subject to this tax, and neither are Social Security benefits. Interest earned from tax-exempt municipal bonds is also not counted.
Allowable Deductions
After totaling your gross investment income, you can subtract certain expenses that are directly related to generating that income. These deductions reduce your gross investment income to arrive at your net investment income figure. Properly allocable expenses can include investment interest expense, which is interest paid on money you borrowed to make investments. Other deductible costs include investment advisory and brokerage fees and state and local income taxes that you pay on your investment income.
The NIIT Calculation Explained
The NIIT calculation involves a comparison of two figures. The tax is calculated on the lesser of your net investment income (NII) or the amount by which your MAGI exceeds the threshold for your filing status.
To illustrate, consider a single filer with a MAGI of $270,000 and NII of $90,000. The MAGI threshold for a single filer is $200,000, so the excess MAGI is $70,000. The NIIT is based on the $70,000 excess MAGI because it is less than the $90,000 of NII. The tax owed would be 3.8% of $70,000, which equals $2,660.
In a different scenario, imagine a married couple filing jointly with a MAGI of $280,000 and NII of $10,000. Their MAGI threshold is $250,000, making their excess MAGI $30,000. Here, the NII of $10,000 is the smaller figure, so the NIIT would be calculated on the $10,000 of NII, resulting in a $380 tax.
The lesser of the two amounts is multiplied by the 3.8% tax rate to determine the final NIIT liability. This amount is an additional tax on top of your regular income tax obligations.
Reporting NIIT on Your Tax Return
Once you have calculated your Net Investment Income Tax liability, you must report it to the IRS. The entire calculation and reporting process is handled on Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts. This form guides you through the steps of identifying your investment income and subtracting allowable expenses to perform the final calculation. You will transfer the figures you have already determined, such as your total investment income and your MAGI, to the appropriate lines on Form 8960.
After completing the form, the final NIIT liability is transferred to your main income tax return, Form 1040. Specifically, the NIIT liability is carried over to Schedule 2, “Additional Taxes,” and included with any other taxes you may owe.