A person's net investment income can play an important role in determining tax liabilities in a given year. In addition to paying taxes on profits from individual investment categories, individuals who earn more than specific thresholds may be required to pay a tax on total investment profits.
What is net investment income?
Net investment income (NII) is the total cash profit generated from stocks, dividend payments, mutual funds, bonds, rental income, and other qualifying sources, minus losses and expenses from investments across these categories.
Depending on an individual's or a married couple's level of total income in a given year, a tax on net investment income may be applied in addition to other existing taxes on investment profits.
Net investment income and taxation
Net investment income is calculated by adding all profits generated across a person's or married couple's investments, then subtracting losses and expenses stemming from trading commissions, fund management costs, brokerage fees, and other sources.
In 2013, a tax on net investment income of 3.8% was adopted and applied to individuals and married couples making certain minimum amounts of modified adjusted gross income (MAGI) in a given tax year. The annual MAGI thresholds that determine whether individuals and married couples are subject to NII tax are as follows:
- Married filing jointly: $250,000 or higher
- Married filing separately: $125,000 or higher
- Single or head of household: $200,000 or higher
- Qualifying widow(er) with a child: $250,000 or higher
For individuals and couples who fall into those brackets and have investment income, a tax of 3.8% is applied to the lesser of either net profits across investment categories or the amount that MAGI exceeds the threshold for NII taxation.
Important things to know about NII and taxes
The net investment income tax is applied on top of other taxes for profits generated from investments. This means that NII taxes must be paid in addition to taxation on specific sources of investment profits in a year, such as capital gains or dividends.
But increases in the prices of an asset or equity alone won't increase a person's net investment income. A person would have to sell the asset or equity and realize the profits as gains for the appreciation to factor into NII calculations. Investments can also be sold at a loss to reduce total net investment income in a tax year -- a strategy known as tax-loss harvesting.
Additionally, steps can be taken to reduce your yearly modified adjusted gross income. For example, deductions from paying student loan debts and making charitable contributions will reduce MAGI and potentially help a person get under the thresholds that would require NII taxes to be paid.
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An example of net investment income and taxes
An individual who generated $10,000 in annual net profits on stocks and $1,000 in dividend income would be taxed at the respective tax rates corresponding to each of those profit sources. If that individual had modified adjusted gross income of $300,000 that year, he or she would also be subject to the net investment income tax.
Because this single filer had MAGI above the $200,000 NII tax requirement threshold, he or she would also be taxed an additional 3.8% on the combined net investment income of $11,000 for that year. He or she would owe an extra $418 in NII taxes.
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