Ep 49: What Is English For "Net Investment Income Tax (NIIT)?"
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What's NIIT?
We discuss NIIT (Net Investment Income Tax), explaining its implications for individuals with investment income and also how it applies in cross-border situations.
We cover the statutory thresholds for the tax, what constitutes net investment income, and the reporting requirements.
We also touch on some fascinating recent court cases that have impacted the application of the NIIT for expats and the potential for foreign tax credits.
Takeaways
The Net Investment Income Tax (NIT) is a 3.8% tax on certain investment income.
There are specific thresholds based on the filing status: $250,000 for married filing jointly, $125,000 for single, and $200,000 for others.
What's included in NITT and what's excluded
How NIIT is impacted by Foreign investment income
How to cover NIIT liabilities, especially on W-2 income.
Episode Links & Resources
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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What Is NIIT (Net Investment Income Tax)?
Jane Mepham, CFP®
And we are back with one of our favorite formats, “a shortie”, in which in 10 minutes or less, we take a term used in used in the cross-border finance/tax space and kind of tell you at a very high level what it is.
So, the other day I was reviewing one of my clients' returns, let's call him John, and John had a really great income and he noticed as I started explaining that he had been charged 3.8 % tax on some income. And so, as I explained to him what this is my thought process was there are quite a few people who may not be aware of it.
So, in today's shortie we're going to tell you or explain what the Net Investment Income Tax is. Manasa, want to jump into it?
The Source Of NIIT
Manasa Nadig, EA
Yeah, it is pronounced NIIT by the way. Because we know we love acronyms. So, the net investment income tax basically depends on two conditions.
- One is that you have investment income and then your MAGI or the Modified Adjusted Gross Income exceeds a certain amount.
The net investment income tax was imposed by section 1411 of the Internal Revenue Code. And this applies a rate of 3.8 % tax on certain investment income of individuals, estates, and trusts that have income over the statutory thresholds. Now, the statutory thresholds are based on your filing status.
So, if you're married filing jointly, or you're a surviving spouse, it's $250,000. If you're single or married filing separately, it's $125,000, and all others are $200,000. So that's when the 3.8 % NIT is applied to your investment income. And basically, you should also note that even if you are someone who is exempt from Medicare taxes, you may still be subject to the NIIT because remember the NIIT is based on investment income and your MAGI being over the thresholds we just talked about.
What Contributes To NIIT
Jane Mepham, CFP®
Okay, so let's define what this net investment income tax itself is. So, in general, investment income includes, but is not limited to, you know, interest, dividends that you most likely see in your brokerage account, passive rental, and royalty income. What's the other one? Non-qualified annuities, income from businesses involved in the trading of financial instruments or commodities.
Manasa Nadig, EA
Good idea.
Jane Mepham, CFP®
Businesses that are passive activities to the taxpayer, and I'm sure Manasa can give you the exact code for that. Capital gains from the sale of stocks, mutual funds, and distributions from mutual funds. Again, this is where we see a lot of it. Sale of investment of real estate, including, which is interesting, the sale of a second home, but not the primary residence.
Sale of interest on partnerships and c-corps to the extent that you're the passive owner. And the way they calculate it, of course, this is higher, right? Your investment income is reduced by sudden expenses properly allocable years to the income. I had to think of that word.
And so then the question is what is not net investment income, Manasa?
Income Not Included In NIIT
Manasa Nadig, EA (04:04)
Yeah, so all of the income that is not investment income is basically, know, like your wages, your unemployment income, the operating income that you have from your non passive businesses, that is the businesses that in which you are an active participant in, of course, your social security benefits, your tax exempt interest, any self-employment income.
And there are some vague stuff in there, like Alaska permanent fund dividends and distributions from some qualified plans, et cetera. So those are not net investment income.
So you do not pay the 3.8 % net investment tax on that.
And so that brings us to how do you report and pay the net investment income tax? So all of this, the net investment income, and your MAGI is looked at on form 8960. And if all of these rules apply to you, then you calculate the 3.8 % tax and it flows to your form 1040 and the 8960 is attached to the1040. And basically you pay this tax.
The same for estates and trusts, but for them, It's calculated on form 1041, whereas the individuals, it's form 1040, of course. And you are also subject to estimated tax provisions if you are subject to this, which is if you fall short on paying your net investment income tax, there will be an income tax penalty that you might end up paying.
So make sure that you're looking at this if that applies to you.
Jane Mepham, CFP® (05:38)
Okay.
How Does NIIT Apply In A Cross-border Context
Manasa Nadig, EA (05:59)
Now, coming to the most interesting part of this is how does the NIIT apply in the cross-border context? So this has been something that we look at on a constant basis. Now, you have a client who's an expat who lives overseas or who lives in the US and has a large amount of foreign income, which comes from investments.
Then we have the net investment income tax apply to that investment income. Now, these same people might also be filing taxes in the other country, but then the income taxes that they are paying in the other country cannot be claimed as a foreign tax credit against the net.
Court Cases and NIIT
Having said that though, there have been recent court cases which have looked at this and for specific countries, which are France and Canada right now, and we link these court cases in our episode notes, they have allowed the tax paid in that country in France and in Canada to be claimed against the NIIT
Jane Mepham, CFP® (07:05)
Yep.
Manasa Nadig, EA (07:21)
On the US tax return. So if you're a financial planner or a tax preparer who sees this, then be aware that this is a possibility and is available. But for the most part, until we have more clarification on this for other countries, foreign tax credit is not allowed against the NIIT.
So, that's more or less everything about the net investment income tax, Jane. Do you have anything to add?
Jane Mepham, CFP® (07:52)
The court cases are interesting and it might be interesting one of these days to just take a bunch of those and kind of talk through them, kind of nerd out on them. But I think you've addressed the most important aspect of it, the two conditions. And I think with that, we hopefully still under 10 minutes we can bring it to a close.
Manasa Nadig, EA (08:12)
Absolutely. one thing that I would like to add here is if you know that this is something that you're subject to and it's a possibility for you and you do not want to have the hassle of paying estimated taxes every quarter and you have a W-2, just increase your withholdings to cover for that. So yes, here's what we conclude the Shortie episode.
Jane Mepham, CFP® (08:32)
Great idea.
Manasa Nadig, EA (08:42)
Thank you so much for listening. If you like this episode and you want to hear more of our shorties, where we distill all of the complex stuff into quote-unquote plain English, please make sure to go on our YouTube and catch one of our episodes there. The handle is the International Money Cafe. So youtube.com forward slash at the International Money Cafe. Thank you so much for listening.
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.