How the Net Investment Income Tax Affects Your Medicare Tax
What is the Net Investment Income Tax?
The Net Investment Income Tax is a 3.8% tax on certain types of investment income. The tax is imposed on taxpayers whose modified adjusted gross income (MAGI) exceeds certain thresholds. The NIIT applies to individuals, estates, and trusts. The types of investment income that are subject to the tax include:
- Interest income
- Dividend income
- Rental income
- Capital gains
- Royalties
- Passive income from partnerships and S corporations
- Annuity income
- Income from the sale of a property held for investment
The NIIT only applies to the amount of investment income that exceeds the applicable threshold. For individuals, the threshold is $200,000 for single filers and $250,000 for married filing jointly. For estates and trusts, the threshold is $12,150 for tax year 2019.
How does the NIIT affect your Medicare tax?
The NIIT is closely linked to the Medicare tax, which is a 2.9% tax that is imposed on all wages and self-employment income. The Medicare tax is split between the employer and the employee, with each party responsible for paying 1.45% of the tax. For self-employed individuals, the tax rate is 2.9%, as they are responsible for paying both the employer and employee portions of the tax.
The NIIT, on the other hand, is only paid by individuals, estates, and trusts that have investment income that exceeds the applicable threshold. The tax is calculated on Form 8960, which is attached to the individual's tax return. The NIIT is calculated separately from the income tax and self-employment tax.
It is important to note that the NIIT does not affect the amount of Medicare taxes that you pay. The Medicare tax is a separate tax that is imposed on all wages and self-employment income, regardless of whether the taxpayer has investment income or not.
How do you calculate the NIIT?
The NIIT is calculated using a complex formula that takes into account the taxpayer's net investment income and modified adjusted gross income. The formula is as follows:
NIIT = (Net investment income - threshold amount) x 3.8%
The threshold amount is the amount that exceeds the taxpayer's applicable threshold. For example, if an individual has $300,000 of net investment income and is married filing jointly, their threshold amount would be $50,000 ($300,000 - $250,000). The NIIT would be calculated on $50,000, which would result in a tax of $1,900 ($50,000 x 3.8%).
It is important to note that the NIIT is an additional tax and is calculated separately from the income tax and self-employment tax. Taxpayers who have investment income will need to complete Form 8960 to calculate the NIIT.
What are the consequences of not paying the NIIT?
Failure to pay the NIIT can result in penalties and interest. The penalty for failing to pay the tax on time is 0.5% of the unpaid tax for each month that the tax is not paid, up to a maximum of 25% of the unpaid tax. In addition, interest is charged on the unpaid tax at a rate of the Federal short-term rate plus 3%.
The Internal Revenue Service (IRS) can also assess accuracy-related penalties if the taxpayer understates their tax liability or fails to file a required tax return. The penalty is equal to 20% of the amount of tax that was understated.
How can you avoid the NIIT?
There are several ways that taxpayers can avoid or reduce the NIIT. One way is to reduce their net investment income. Taxpayers can do this by investing in tax-exempt bonds or other tax-advantaged investments, such as retirement accounts.
Another way to reduce the NIIT is to reduce your modified adjusted gross income (MAGI). Taxpayers can do this by contributing to a qualified retirement plan, such as a 401(k) or IRA, or by taking advantage of other deductions and credits.
Summary
The Net Investment Income Tax is an additional tax that affects taxpayers who have certain types of investment income and whose income is above certain thresholds. The NIIT is calculated separately from the income tax and self-employment tax and is imposed at a rate of 3.8%. Failure to pay the NIIT can result in penalties and interest. Taxpayers can avoid or reduce the NIIT by reducing their net investment income or their modified adjusted gross income. If you have questions about how the NIIT affects your Medicare tax, consult with a qualified tax professional.