The United States has very generous tax rates for investment income such as qualified dividends and long-term capital gains, as low as 0%. This is a key component of the Never Pay Taxes Again strategy.
But sometimes you want (need?) to realize some large gains – say, if you are paying cash for a boat or a house, or if you are moving from a low-tax to a high-tax residence and want a massive step-up in basis. Or maybe you think the market is hot and you want to take some off the table.
In these cases you may come across the Net Investment Income Tax, a nice little 3.8% extra tax surcharge.
Net Investment Income Tax
The Net Investment Income Tax shouldn’t be an everyday or every year thing, it applies to investment income above a fairly large threshold.
Tax status – NIIT Threshold
Married Filing Jointly – $250,000
Head of Household – $200,000
Single – $200,000
Married Filing Separately – $125,000
The tax applies to passive / investment income only, which includes things like dividends, interest, capital gains, royalties, and rental profits. Income from a job or self-employment, qualified IRA distributions, Social Security, or municipal bond interest (for some reason) are not subject to NIIT. (This pdf from Ameriprise is a pretty good summary of how each income type is taxed.)
Only the investment income above the NIIT Threshold will be subject to the NIIT.
A Married Filing Jointly household has $250,000 in income from various sources. This is at or below the NIIT threshold so NIIT = $0.
This same couple realizes an additional $100,000 capital gain, for total AGI of $350,000. The investment income above the $250,000 NIIT threshold is taxed at 3.8%. NIIT = $3,800.
A Married Filing Jointly household has $300,000 in income from self-employment and $10,000 in dividends. All of the dividends will be taxed at 3.8% for a total of $380.
You can explore various options for your unique situation using our (new and improved) income tax calculator.
If you are subject to NIIT, this all gets sorted on Form 8960 (pdf.)
Avoiding the NIIT
Most people will have no problem avoiding this tax simply by never having an AGI of more than $250,000 (or respective threshold.) Super easy.
You can also avoid it (or at least minimize it) by spending 8 or 9 years harvesting tax-free capital gains before you decide to make that big boat or house purchase.
If you can’t avoid a large realized gain, try to split it across 2 years if possible. Buying a house in January may be better than buying a house in, say, July, as you can sell half of your investments on December 31st and the other half on January 1st, thereby splitting the gain across two tax years. (This can also be accomplished by borrowing – using a mortgage or asset backed loan to realize gains over multiple tax years.)
You sell your blog for a big capital gain. If the buyer is a reliable entity (e.g. a large corporation) consider an installment plan where you get paid over 2 or 3 years instead of all at once.
If none of the above are possible, then just pay the tax. 3.8% is a small price to pay, albeit important for it to be intentional vs accidental.
The Net Investment Income Tax is an extra 3.8% tax surcharge in years with big investment income.
If you can’t stay under the fairly large thresholds, just be aware that you have to pay a wee bit more tax.
Our income tax calculator now calculates a simple form of NIIT to aid in your tax minimization efforts.