By Bob Palechek, CPA | October 2, 2020

Today’s blog is about Net Investment Income Tax, otherwise referred to as “NIIT”.   NIIT came into existence on January 1, 2013, and applies to individuals, estates, and trusts.  The focus for today is on individuals.

NIIT is a tax on certain types of investment income applied at 3.8% if the taxpayer has income above certain income thresholds.   The income thresholds for single filers is Modified Adjusted Gross Income (MAGI) above $200,000.   For married filing jointly files, the MAGI amount is $250,000.  These thresholds have been the same since 2013 and are not indexed for inflation.

The 3.8% is applied to the lower of net investment income or the amount of your MAGI that exceeds the applicable threshold amount.   For example, if a married couple has net investment income of $150,000 with a MAGI of $305,000, then the 3.8% tax will be applied to $55,000 (since $305,000-$250,000 is lower than $150,000).   In this scenario, the NIIT tax reported and owed will be $2,090.  The calculation and reporting of NIIT is found on IRS Form 8960.

Types of Investment Income included in NIIT:

-Interest and dividends (including qualified dividends)

-Capital gains and capital gain distributions

-Rent and royalty income

-Non-qualified annuities

-Income and gains from passive activities (where the owner is not involved)

-Gains from the sale or disposition of those passive activities

Types of Investment Income not included in NIIT:

-Tax-exempt interest

-Distributions from qualified plans (typical IRA’s ROTH’s, and 401(k)’s)

-Any portion of the gain on your home if excluded under Section 121.

So RMD’s from my IRA are not subject to NIIT?   Correct, but if the RMD amount raises your MAGI above the applicable threshold, it will trigger NIIT on your net investment income.  This is especially important when looking at Roth Conversions!  If this causes an additional 3.8% tax on your investment income, it should be factored into the current cost of the Roth Conversion.  Fortunately, the tax planning software we utilize factors all of this into the Roth Conversion Analysis plans we perform for our clients.

One last common item that I see preparers miss on tax returns:   If a business that you own and operate rents from real estate that you also own, a sale of that real estate that generates a capital gain is excluded from NIIT.  The IRS allows the gain to be considered as part of the business activity and not subject to the 3.8% additional tax, if applicable.