Posted by Fred Lake

What is the Net Investment Income Tax (NIIT) or 3.8% Medicare tax?

What is the Net Investment Income Tax (NIIT) or 3.8% Medicare tax?

If you sell stocks, mutual funds, or other assets that you have held for at least a year, any profit from the sale will be taxed at the rate of 0%, 15%, or 20%. These long-term capital gains tax rates are usually much lower than the normal tax rates you would otherwise pay, which can be as high as 37%.

Many investors who sell real estate or other high-value investments are often surprised to find that their tax obligations may be subject to an additional 3.8% tax, in addition to the applicable capital gains tax rates—short or long term. The Net Investment Income Tax or Medicare tax is an additional 3.8% imposed by Section 1411 of the IRC on investment income. The NIIT came into effect on January 1, 2013, and can be applied to high-income taxpayers (individuals and trusts) whose Modified Adjusted Gross Income (MAGI) exceeds a certain legal limit.


What are the legal limits of NIIT?

Individuals must pay tax if they have net investment income and MAGI above the following limits:

Filing Status

Threshold Amount

Head of household (with qualifying person)

$200,000

Married filing jointly

$250,000

Married filing separately

$125,000

Qualifying widow(er) with dependent child

$250,000

Single

$200,000

 


Note: Taxpayers should know that these limit values are not indexed for inflation. If you are a Medicare exempt person, you may still be subject to net investment income tax (NIIT) if you have net investment income and have modified adjusted gross income beyond applicable limits. 


Long-term capital gains and NIIT:

The federal tax rate corresponding to the taxpayer's capital gains depends on the taxpayer's income which, depending on the filing status, is included in one of the three brackets and is allocated at one of the three corresponding rates: 0 %, 15%, or 20%. The income brackets for capital gains taxes are adjusted for inflation, so they change every year, unlike the NIIT limits described above.

2021 Capital Gains Tax Rates and Brackets

Rate

Single Taxpayer

Married Filing Jointly

Head of Household

0%

$0 – $40,400

$0 – $80,800

$0 – $54,100

15%

$40,401 – $445,850

$80,801 – $501,600

$54,101 – $473,750

20%

$445,851+

$501,601+

$43,751+


So in practice, the NIIT can not only apply to those at the top of the capital gains tax rate, creating 23.8% debt, but it can also apply to taxpayers at the top of the mid-section (15%) who benefit from its potential liability into 18.8%. For example, a couple with an income of $350,000 would be out of the 20% range, but a portion of their earnings would be subject to 18.8% (15% + 3.8%) tax because it exceeds the $ 250,000 NIIT limit. If the same couple earned a total income of $ 525,000, part of their income would be taxed at 23.8% (20.0% + 3.8%).


Application

It is important to note that tax is only levied on net investment income. Net investment income comprises capital gains from the sale of investment properties and most of the rents (property held as passive activity). It excludes sales of shares of companies and S-Corps in which the seller has been actively involved in the business. The sale of real estate owned by subchapter C Corps and actively used in a business or trade activity is not taxable because there is a business use instead of being held for investment. However, C-Corp shares are considered a passive investment and are subject to NIIT.

NIIT only affects individuals, funds and property, and any entity whose income is transferred from investments: tax corporations or small corporations.

NIIT is reported on Form 8960.


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Fred Lake
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