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Watch out for the Net Investment Income Tax, or NIIT Thumbnail

Watch out for the Net Investment Income Tax, or NIIT

Have you heard of the Net Investment Income Tax, or NIIT??? If you haven’t, you’re not alone.

The Net Investment Income Tax is a sneaky extra 3.8% tax you have to pay on your sources of passive investment income if your gross income is over a certain level.

Specifically, NIIT uses a special definition of Modified Adjusted Gross Income, or MAGI, to determine when the extra tax may apply. For most people, the NIIT MAGI will simply equal Adjusted Gross Income, or AGI.

If you’re married and file a joint tax return, you’ll be subject to NIIT if your MAGI exceeds $250,000. If you’re single, the threshold decreases to $200,000. If you’re married and file a separate tax return, the threshold further decreases to $125,000.

If your MAGI is over your respective threshold, your passive investment income may be subject to an additional 3.8% tax on top of whatever tax you already have to pay. The forms of income subject to the extra tax include:

  • Interest
  • Dividends
  • Income from non-qualified annuities (i.e. those NOT held inside an IRA)
  • Passive income from rental properties, royalties, partnerships, S corporations, trusts, etc.
  • Capital gains from selling investments

While having to pay an extra 3.8% tax on passive income isn’t necessarily going to break the bank, it’s nonetheless something to be aware of and avoid if you can.

Since NIIT looks at all your other sources of taxable income to determine if your MAGI is over the threshold, you want to be cognizant of how your other income can potentially invoke NIIT.

For example, if you’re considering doing Roth conversions, keep in mind that amounts converted will be added to your AGI, which means they will be included in your NIIT MAGI. Therefore, doing conversions may make you subject to NIIT when you otherwise wouldn’t be.

NIIT is a great example of how taxes aren’t as simple as just tax rates and brackets. There are forms of indirect and quasi-hidden taxes like NIIT that can come into play and increase your effective tax rate. So, keep things like NIIT in mind when doing tax planning and projections.

For more information on the Net Investment Income Tax, check out my recent YouTube video, What is Net Investment Income Tax ("NIIT")?