The net investment income tax is just one example of the complicated nature of the U.S. tax laws. The NIIT was a surtax that was created as part of the Patient Protection and Affordable Care Act, taking effect in 2013 and supplementing the revenue from Medicare payroll taxes on earned income by broadening its effective reach to unearned investment income. The 3.8% tax applies to high-income taxpayers, but because of its origins within Obamacare, the NIIT will likely be among the first tax provisions that the Trump administration looks to repeal. Below, we'll look more closely at the net investment income tax and how it works.
What the net investment income tax does
The net investment income tax imposes a 3.8% tax on income from investments. That includes interest, dividends, and short- and long-term capital gains, as well as rental and royalty income and business income from activities that are treated as passive from the taxpayer's standpoint. It also includes gains from the sale of a primary residence to the extent that they exceed the $250,000 or $500,000 exemptions from tax on residence-related gains.
In calculating net investment income, taxpayers are allowed to deduct certain expenses that are tied to that income -- even if they would otherwise only be allowable as itemized deductions for regular income tax purposes. That includes investment interest expense, brokerage fees, investment advisory fees, tax preparation fees, expenses related to rental and royalty income, and state and local income taxes on the investment income.
The net investment income tax only applies to certain high-income taxpayers. Specifically, taxpayers who have adjusted gross income of more than $200,000 for single filers or $250,000 for joint filers will have to pay the tax on investment income that exceeds these threshold amounts. For instance, if a single filer has $190,000 in salary income and $20,000 in investment income, then the net investment income tax is imposed only on the $10,000 by which the total income of $210,000 exceeds the $200,000 threshold limit.
Why the net investment income tax might go away
The net investment income tax is here to stay through 2016, so you can expect to see it on your 2016 tax forms come early next year. However, after the election of President-elect Donald Trump, the net investment income tax might well be on the endangered species list.
Trump's tax plan during his campaign included dramatic simplification of the current income tax rate structure, replacing seven current brackets with just three. New brackets of 12%, 25%, and 33% would be the only ones under the new system, and the tax plan would eliminate the net investment income tax in the name of further simplifying taxes.
How to put off paying net investment income tax
As a result, you might want to take steps to minimize your liability in 2016, in the hopes that you won't have to worry about the net investment income tax for tax year 2017 and thereafter. The easiest way to do that is to look at harvesting tax losses by selling off investments that you own on which you've currently lost money. That's generally a good idea even under the regular income tax, because capital losses are fully deductible against capital gains and can also offset up to $3,000 of other types of income. For net investment income tax purposes, the same is true, and capital losses can reduce the amount of NIIT you pay.
The other thing you can do is seek to keep your overall income below the threshold limits at which the NIIT gets imposed. That's usually more difficult, but steps like delaying taking withdrawals from traditional IRA or 401(k) accounts or deferring income you expect late in the year until early next year could keep your income down, thereby helping you avoid the tax.
The net investment income tax isn't very old, but its days might be numbered under the incoming Trump administration. Even though you'll still face the provision on your 2016 tax return, efforts you make to minimize it now could get rewarded in the years to come.