As the year is coming to a close, many traders are starting to wonder what their tax liability will be for 2013. One of the most significant tax changes this year is the Net Investment Income Tax (NIIT), which originated with the Affordable Care Act. Here is what you need to know about NIIT.
What Is The Net Investment Income Tax?
The Net Investment Income Tax is a 3.8% tax on certain net investment income of individuals, estates, and trusts with income above statutory threshold amounts.
What Is Included In Net Investment Income?
In general, investment income includes, but is not limited to: interest, dividends, long and short term capital gains, rent and royalty income, non qualified annuities, income from businesses involved in trading of financial instruments or commodities, and passive business activities such as rental income or income derived from royalties.
What Is Not Included In Net Investment Income?
Wages, unemployment compensation, operating income from non passive business, Social Security benefits, alimony, tax exempt interest, self employment income, Alaska Permanent Fund Dividends, and distributions from certain qualified plans are not included in net investment income.
Individuals
Individuals whose modified adjusted gross income exceeds $250,000 (married filing jointly) or $200,000 (single filers) are taxed at a flat rate of 3.8% on investment income. Net Investment Income Tax is paid in addition to other taxes owed. Non-resident aliens are not subject to the tax; however, if a non-resident alien is married to a US citizen and is planning to file as a resident alien for the purposes of filing “married filing jointly,” there are special rules. Please consult a tax professional if you fall into this category.
The tax is calculated based on the lesser of your modified adjusted gross income above the thresholds or your Net Investment Income.
Estates And Trusts
Estates and Trusts are subject to the NIIT if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. In 2013, this threshold amount is $11,950.
Real Estate Investment Trusts (REIT) are not subject to NIIT at all. However, it should be noted that non-qualified dividends generated by investments in a REIT are considered taxable income and taxed at ordinary tax rates. As such, they may be subject to the NIIT.
What Investment Expenses Are Deductible When Calculating NIIT?
In order to arrive at Net Investment Income, your Gross Investment Income is reduced by deductions that are properly allocable to items of the Gross Investment Income. Some examples of these deductions are investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income.
Example Of A Trader Not Subject To NIIT
A trader, who is single, has wages of $150,000 and capital gains from trading of $40,000. The modified adjusted gross income is $190,000, which is less than the $200,000 statutory threshold. Therefore, the trader is NOT subject to NIIT.
Example Of A Trader That Is Subject To NIIT
A trader, who is single, has wages of $150,000 and trading gains of $70,000 for the year. The modified adjusted gross income is $220,000 and exceeds the threshold by $20,000. The Net Investment Income is $70,000. The NIIT is based on the lesser of $20,000 (amount over the threshold) or $70,000 (Net Investment Income). This trader owes NIIT of $760 ($20,000 x 3.8%)
If you are wondering how the Net Investment Income Tax affects you, please seek the advice of a qualified tax professional. It’s never too late to do some tax planning!
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Read his story in the TraderPlanet Journal on how you can still save money on your taxes this year.
Learn more about Ribble’s tax practice for traders here. E-mail Steve here with questions or for a free consultation.
