The Nasty Tax

Here we are, 2 years after getting rooked with a 5 dimensional tax system, and many people are still unaware of the Nasty Tax: 3.8% Net Investment Income Tax (NIIT). I think the IRS used Wal-Mart pricing strategy with 8’s when they derived the number so it the smell would go un-noticed. But since it’s tax time, let’s talk about what’s in the baggie.

The NIIT is a surtax of 3.8% that covers a broad category of investment income sources. Determining how the tax is applies involves a fairly simple two step calculation. But first, let’s cover what’s included.

What’s Included: interest, dividends, annuities, royalties, rents, income from a business that is a passive activity with respect to the taxpayer, and net capital gain on the sale of non-business assets, reduced by any deductions properly allocable to such income.

Does not include salaries, wages, bonuses, distributions from IRAs or qualified plans, or self-employment income.

Are You Affected?

3.8% surtax that applies to the lesser of: 1. Net investment income (NII) or 2. The excess of your modified adjusted gross income (MAGI) over $200,000 (Single) or $250,000 (Married filing jointly). Remember, your MAGI is the amount reported on the last line one page 1, Form 1040.








First, add up your income subject to the Surtax.

Subject to Surtax Exempt from Surtax
Wages      X
Taxable Interest      X
Exempt Interest      X
Dividends      X
Annuity Income      X
Passive Royalty      X
Active Royalty      X
Rents      X


Next, look at the Threshold Amount

• Single taxpayers – $200,000
• Married taxpayers – $250,000
• Estates/trusts – $12,150

Example: Tammy, a single taxpayer, has $225,000 of net investment income and no other source of income. The 3.8% surtax would apply to $25,000 of income. (the lesser of investment income of $225,000 or the excess of $225,000 MAGI over $200,000 “threshold amount”).

Example: David & Darla, married filing jointly, have $200,000 of salaries and $150,000 of net investment income for total MAGI of $350,000.
The 3.8% surtax would apply to $100,000 of income because the excess of $350,000 MAGI over $250,000 threshold amount is $100,000 and LESS than their NII of $150,000.

How to Reduce NIIT

1. Look at Your Dividends. There can be a meaningful difference in the tax rate on ordinary versus qualified dividends (43.4% versus 23.8% highest brackets).

  • Review your 1099 statements.
  • Lines 9a and 9b on your 1040:

Tax-inefficient mutual funds can generate short-term capital gains, which are classified as ordinary dividends. Consider a tax-managed implementation, or if dividends are not needed for cash flow again, consider asset location.

  • Taxation of Traditional Dividends- Ordinary Income
  • Taxation of “Qualified Dividends” – Capital Gains Rate of 15%

2. Taxable Interest: Interest Income is taxed at ordinary income rates. Consider ways to reduce taxable interest with municipal bonds versus taxable bonds.
Consider asset location; placing tax-inefficient asset classes in tax-deferred and taxfree accounts.

  • Lines 8a and 8b on your 1040:

3. Capital Gains: Long-term Gains are Taxed at Lower Tax Rates
Reduce the capital gains by using these tools:

  • Tax-lot accounting: A method of accounting for a securities portfolio that tracks the purchase, sale price and cost basis of each security. This allows the manager to “swap” a batch of stocks with long-term gains for a batch with smaller, short-term gains.
  • Loss harvesting: Holding a stock at a loss to sell all or part of it to realize the loss and create an “asset” that may help offset some future gain.
  • Gain-loss offset: Involves selling securities at a loss that have dropped in price at year-end to help offset gains from selling securities that have increased in price.
  • Charitable donations through gifting low basis stock.Line 13 on your 1040: In most cases, the optimal amount that should be here is -$3,000. The law allows a taxpayer to take losses equal to gains and then an additional $3,000 against ordinary income. If a positive number is reported here, were tax loss harvesting opportunities missed?
  • Master Limited Partnerships (MLP’s): Deduction pass-throughs, lower taxable income, and tax deferral on distributions.

Got Questions?

Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.