High-income earners may face additional taxes: the 3.8% Net Investment Income Tax (NIIT) and a 0.9% additional Medicare tax on wages and self-employment income. Let’s explore the potential impact these taxes could have on you
How the NIIT impacts high-income earners
In addition to income tax, the NIIT applies to net investment income if your adjusted gross income (AGI) exceeds $250,000 for joint filers, $200,000 for single filers, and $125,000 for married individuals filing separately.
The tax is applied to the lesser of your net investment income or the excess of your AGI above those thresholds. The “net investment income” that’s subject to the NIIT consists of interest, dividends, annuities, royalties, rents and net gains from property sales, but not wages or income from an active business.
Additionally, passive business income is taxed under the NIIT.
Income that is exempt from income tax—like interest from tax-exempt bonds—is also exempt from the NIIT. Therefore, converting some taxable investments into tax-exempt bonds can help reduce your exposure. Just make sure to consider your income needs and investment goals before making any changes.
The NIIT can apply to home sales if the gain exceeds the exclusion limit: $250,000 for single filers, $500,000 for joint filers. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, falls under the scope of the NIIT, as well.
Income from qualified retirement plans, like pensions or IRAs, is exempt from the NIIT, but distributions could raise your AGI, triggering the tax on other income.
The additional Medicare tax
In addition to the 1.45% Medicare tax that all wage earners pay, high-wage earners may owe an extra 0.9% Medicare tax on wages exceeding $250,000 for joint filers, $200,000 for single filers, and $125,000 for those married filing separately.
Employers must begin withholding the tax once an employee earns $200,000, but this withholding may not cover all tax owed if you or your spouse have other income sources. Instead, an employee can ask that extra income tax be withheld by filing a new Form W-4 with the employer.
The 0.9% tax also applies to self-employment income above those thresholds, on top of the regular 2.9% Medicare tax.
Mitigate the Effects
These two taxes can have a significant effect on your tax bill, but with guidance, you can take steps to protect yourself. Reach out to your Smolin advisor and learn how to lessen their impact.