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How the Net Investment Tax Works

Net investment tax is a 3.8% surtax on a portion of your modified adjusted gross income (MAGI) over certain thresholds. You might be subject to it even if you manage to avoid paying significant income taxes on your investment income by using deductions and credits.

Let’s see what the IRS says:
You’re liable for a 3.8% net investment income tax on the lesser of your investment income or the amount your MAGI exceeds the statutory threshold amount based on your filing status:

Net investment income includes but is not limited to interest, dividends, capital gains, rental and royalty income, nonqualified annuities, and income from businesses involved in the trading of financial instruments or commodities.

What doesn’t it include? Wages, unemployment compensation, Social Security benefits, alimony, distributions from certain qualified plans, and most self-employment income. Any gain on the sale of a personal residence excluded from gross income for regular income tax purposes is also  excluded from net investment income.

If you owe net investment income tax, file Form 8960, which contains details on how to figure the amount of investment income subject to the tax. If you have too little withholding or you fail to pay enough quarterly estimated taxes to cover the net investment income tax, you’ll be subject to an estimated tax penalty.

The net investment income tax is imposed not only on individuals, but also on estates and trusts if they have undistributed net investment income and an adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for a taxable year.

There are special computational rules for certain unique types of trusts, for instance, for qualified funeral trusts, charitable remainder trusts and electing small business trusts. Trusts not subject to the net investment income tax include charitable trusts, qualified retirement plan trusts exempt from tax and charitable remainder trusts exempt from tax.

Keep in mind that if you owe this tax, the IRS expects you to make quarterly estimated payments on the amount you think you’ll owe.

Some federal income tax credits that may be used to offset a tax liability may be used to offset the net investment tax. You may want to consult a tax professional to make sure you get your calculations right.

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