2020 was a big year. Are you sitting on capital gains?
Many individuals who have invested in the stock market prior to 2020 are likely sitting on large capital gains.
Now is the time to understand whether or not to sell investments. Read more to learn how the Net Investment Income Tax can impact your decision.
2020 was a big year for investing in the stock market. Many individuals are unsure whether they are sitting on great financial gains and returns, or if they should let go of some investments. Before making a choice, one might want to consider looking into something many do not know about: the Net Investment Income Tax (NIIT).
Net Investment Income Tax takes a total of 3.8% off your investment earnings. The tax applies to certain individuals and estates, however, most are unaware that the tax exists. In some cases, it may even drive capital gains rate much higher than people might expect.
Zen Wealth Management Group has created a guide to walk through rules and restrictions that the Net Investment Income Tax imposes.
What is the Net Investment Income Tax?
The Net Investment Income Tax (NIIT) is an IRS tax that applies to certain individuals, estates, and trusts in relation to their net investment income. This tax generally applies to the lesser of one’s net investment income, or the amount by which your modified adjusted gross income surpasses the filing status-based threshold regulated by the IRS. The NIIT is set at 3.8% for both the 2020 and 2021 tax seasons.
The NIIT was created to help fund healthcare reforms and went into effect in January of 2013.
Who is subject to the Net Investment Income Tax?
Individuals subject to the NIIT are frequent net investment income taxpayers, as these individuals represent a large portion of the investment market. Generally, U.S. citizen with a net investment income that exceeds the MAGI thresholds in the table below are required to pay the NIIT.
Estates and trusts are also subject to the NIIT. Typically, estates and trusts that have both undistributed net investment income and adjusted gross income past the dollar amount at which the highest estate/trust tax bracket begins for the current year.
The IRS specifies that there are a few types of trusts not subject to the NIIT:
Trusts exempt from income taxes
Grantor trusts
Trusts not classified as “trusts” for federal income tax purposes
Perpetual care trusts
Electing Alaska Native Settlement Trusts
What is Net Investment Income?
Generally, investors aim to buy investments at a lower price than they will eventually sell them for so that they may turn profit. However, there are many different types of investments and not all are included as net investment income.
Below is detailed chart the displays what is and is not subject to the NIIT:
| Net Investment Income Inclusions and Exclusions | |
|---|---|
| Included as Net Investment Income | - Interest - Capital gains - Dividends - Income from passive investment activites - Non-qualified annuity distributions - Rental and royalty income |
| Excluded from Net Investment Income | - Wages - Uneployment payments - Self-employment income - Social Security benefits - Distributions from some qualified retirement plans - Alimony - Tax-exempty interest - Operating income from nonpassive businesses - Excluded capital gains earned from the sale of your primary residence - Alaska Permanent Fund Dividends |
How do you file the Net Investment Income Tax?
To calculate your net investment income, you may utilize IRS Form 8960.
To report and pay your NIIT, you can do so using Form 1040.
Any estates and trusts looking to file the NIIT should use Form 1041.
If you come across issues or have specific questions related to this tax, contact Eddie Patel Inc. and we’ll connect you with a financial advisor.