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One tax most are not familiar with is the Net Investment Income Tax or NIIT. This is also sometimes referred to as the Obamacare surcharge as a tax created in the same legislation as the Health Care and Education Reconciliation Act of 2010, with NIIT taking effect in 2013.

This is a 3.8% tax on high earners—specifically, those whose modified adjusted gross income or MAGI meets the tax threshold above $200,000 for a filing status of single and head of household, $250,000 for married filing joint and qualifying widower, and $125,000 for married filing separately. Earning these incomes would put your income in the top 10% in the United States for 2022. Please note that MAGI is not on your federal 1040 tax return form, but AGI can be found on line 11 of the 1040.

These minimum income levels have been at the same level since the laws passed, meaning there’s no inflation index for these numbers, which most tax limits have. Because of this, it’s starting to apply to more and more people as wages have increased more than usual in the last several years.

What is subject to the net investment income tax?

· Interest

· Dividends (Qualified or Non-Qualified)

· Sale of assets (rental homes, stocks, or any other security), whether they are subject to short or long-term capital gains rates

· Rental / Royalty income

· Non-Qualified Annuity distributions

· Income from passive income activities

What is not subject to the net investment income tax?

· Wages

· Social Security or Veteran’s Benefits

· Pensions

· Tax-Exempt Interest (Municipal Bonds)

· Qualified Retirement Distributions (IRA, 401(k))

· Tax-Exempt Income from the sale of your primary home

· Life insurance proceeds

· Operating Income from non-passive businesses

There are several ways to reduce your taxable income to avoid this tax by using certain financial accounts: Traditional 401(k) / 403(b), SEP / Simple IRA, Health Savings Accounts (HSAs), Flexible Spending Accounts (FSA), and Dependent Care Savings Accounts (DCSA). The items subject to NIIT stack on top of your ordinary income or those not subject to the tax.

Let’s look at an example:

Mary and Paul have an adjusted gross income (AGI) of $180,000 in 2022. They owned a rental real estate property that they sold that netted a $100,000 long-term capital gain in 2022. They had $2,000 earned in their High Yield Savings Account. They had dividends of $3,000. Their total AGI added up to $285,000 for the year. $35,000 is above the $250,000 NIIT threshold and thus subject to NIIT, which would result in an additional $1,330 owed in federal income taxes.

As you can see in this example, taxes can greatly impact your financial plan and goals. That is why at Whitaker-Myers Wealth Managers, we have a CPA on our team so that we are equipped to help you in all areas of your finances. If you have any questions on how this tax may apply, please contact me, Andrew Young, or Kage Rush, CPA.

The High Earners Tax - Net Investment Income Tax

August 17, 2023

Andrew Young

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