Net Investment Income Tax Basics

The new Net Investment Income Tax that went into effect this year is a source of confusion for some investors.  The IRS has answered some of the more common questions about the tax which should help resolve the confusion for most investors.

The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code (IRC). The NIIT applies at a rate of 3.8 percent to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.  The NIIT will affect income tax returns of individuals, estates and trusts for their first tax year beginning on (or after) Jan. 1, 2013 calculated using a tax return calculator.

Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing Status

Threshold Amount

Married filing jointly

$250,000

Married filing separately

$125,000

Single

$200,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$250,000

Taxpayers should be aware that these threshold amounts are not indexed for inflation.

If you are an individual that is exempt from Medicare taxes, you still may be subject to the Net Investment Income Tax if you have Net Investment Income and also have modified adjusted gross income over the applicable thresholds.

In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC section 469). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income.

In order to arrive at Net Investment Income, Gross Investment Income (items described in items 7-11 above) is reduced by deductions that are properly allocable to items of Gross Investment Income. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income.

The Net Investment Income Tax is subject to the estimated tax provisions. Individuals, estates, and trusts that expect to be subject to the tax in 2013 or thereafter should adjust their income tax withholding or estimated payments to account for the tax increase in order to avoid underpayment penalties. For more information on the Net Investment Income Tax visit IRS.gov.

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