INDIVIDUAL TAX | 10/18/2024
If you have a high income, you may be subject to two additional taxes: the 3.8% Net Investment Income Tax (NIIT) and the 0.9% Additional Medicare Tax on certain earnings. Here’s an overview of how these taxes work and strategies to help minimize their impact.
1 The 3.8% Net Investment Income Tax (NIIT)
The NIIT applies to certain types of investment income for taxpayers with adjusted gross income (AGI) above specific thresholds:
- $250,000 for joint filers.
- $200,000 for single taxpayers and heads of household.
- $125,000 for married individuals filing separately.
How Is the NIIT Calculated?
The NIIT applies to the lesser of:
- Your net investment income for the tax year, or
- The excess of your AGI over the applicable threshold.
What Counts as Net Investment Income?
Net investment income includes:
- Interest, dividends, annuities, royalties, and rents.
- Net gains from property sales.
- Passive income from businesses.
Exclusions:
- Income from active trade or business is not included.
- Tax-exempt income, such as municipal bond interest, is also excluded.
Does the NIIT Apply to Home Sales?
– Principal Residence: Up to $250,000 of gain ($500,000 for joint filers) may be excluded from income tax and the NIIT.
– Excess Gain: Any gain exceeding the exclusion limit is subject to the NIIT.
– Vacation Homes/Second Residences: These gains do not qualify for the exclusion and are fully subject to the NIIT.
Retirement Plan Distributions
Distributions from qualified retirement plans (e.g., pensions and IRAs) are not subject to the NIIT. However, such distributions can increase your AGI, potentially triggering the NIIT on other income.
2 The 0.9% Additional Medicare Tax
This tax applies to high-wage earners and self-employed individuals:
- Thresholds:
- $250,000 for joint filers.
- $200,000 for single filers.
- $125,000 for married individuals filing separately.
For Wage Earners
– Employees already pay a 1.45% Medicare tax on all wages. The additional 0.9% tax applies to wages exceeding the thresholds.
– Employer Withholding: Employers must begin withholding the extra tax when an employee’s wages exceed $200,000. However, withholding may be insufficient if:
– The employee has additional income from another job.
– Both spouses earn wages that collectively exceed the threshold.
– Mitigation Tip: Employees can request additional withholding by filing a new Form W-4 with their employer.
For Self-Employed Individuals
- Self-employed individuals pay the 2.9% Medicare tax on all self-employment income. The additional 0.9% tax applies to earnings exceeding the thresholds.
- The wage thresholds for the 0.9% tax are reduced by any wages earned during the year.
Strategies to Mitigate the Impact
- Review Investment Income
- Shift taxable investments to tax-exempt bonds where appropriate.
- Consider the timing of capital gains to manage your AGI.
- Plan Retirement Withdrawals
- Distribute retirement funds strategically to avoid crossing AGI thresholds unnecessarily.
- Coordinate Wage and Self-Employment Income
- Monitor total wages and self-employment income across all sources to manage exposure to the additional Medicare tax.
- Optimize Tax Withholding
- Use additional withholding to avoid underpayment penalties related to the 0.9% Medicare tax.
How We Can Help
Our tax professionals can analyze your financial situation to:
- Determine if these taxes apply to you.
- Develop strategies to minimize their impact.
- Ensure compliance with withholding and reporting requirements.
Contact us today to discuss how we can help manage the effects of these additional taxes on your overall tax liability.