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What is the Net Investment Income Tax( NIIT)?

Net Investment Income Tax(NIIT)
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Patrick O'Hara , EA
"Net investment income" is defined in section 1411 of the internal revenue code.

Beginning January 1, 2013, taxpayers will pay an additional 3.8% Medicare tax on the lesser of:

•The taxpayer’s “net investment income,” or
•The taxpayer’s “modified adjusted gross income” less the “applicable threshold.”
Clearly, some definitions are in order:

Net Investment income includes:

• Interest, dividends, capital gains, rent and royalty income, and non-qualified annuities,
• Income and gains from passive activities,
• Income and gains from businesses involved in the trading of financial instruments and commodities, and
• Gains from the sale of interests in partnerships and S corporations to the extent the taxpayer is a passive owner.

Net Investment Income doe NOT include:

What types of income are excluded from "net investment income"?

•Tax-exempt bond interest.
•Veterans' benefits.
•Excluded gain ($500,000 for Married Jointly, $250,000 for others) from the sale of a principal residence that is excluded from gross income for income tax purposes.

Investment income doesn't include amounts subject to Self-Employment Contribution Act (SECA) taxes. Specifically, net investment income doesn't include any item taken into account in determining self-employment income for the tax year, if that item is subject to the HI portion of SECA taxes.

Qualified retirement plan distributions aren't included in investment income. Specifically, net investment income doesn't include any distribution from a plan or arrangement described in IRC Sections:

•401(a) (qualified pension, profit-sharing, and stock bonus plans)
•403(a) (qualified annuity plans)
•403(b) (annuities for employees of tax-exempt organizations or public schools)
•408 (individual retirement accounts-IRAs)
•408A (Roth IRAs)
•457(b) (deferred compensation plans of state and local governments and tax-exempt organizations).

However, distributions from these qualified retirement plans can trigger the tax by increasing gross income. This is especially problematic when the taxpayer intiates a Roth Conversion.
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