Effective as of January 1, 2013, a new 3.8% tax went into effect. The
IRS has chosen to call this tax, the Investment Income Tax. In Code
section 1411 this tax is called the Unearned Income Medicare
This new 3.8% tax applies to certain individuals having net investment
income and certain estates and trusts having net investment income. To
determine the tax owing, a person will multiply 3.8% time the lesser of:
(1) his or her net investment income (NII) or a person's modified
adjusted gross income as reduced by a threshold amount as set forth in
the following table:
This tax will be owed only if an individual has net investment income
and his or her modified adjusted gross income exceeds the applicable
threshold amount. Note the discrimination in favor of a single person
versus a married person.
The new tax means an individual before taking an IRA distribution
will want to determine if he or she will have to pay the 3.8% tax on
account of such distribution. For most people and situations, a
person will not owe the 3.8% tax on his or her IRA or pension
distribution, but in some situations the tax would be owed.
There will be times when a person’s IRA distribution will mean the
individual will have to pay the 3.8% tax on the IRA distribution.
Example. David has wage income of $160,000, he withdraws $10,000 from
his traditional IRA and he has dividend income of $40,000. David’s tax
filing status is single. David’s tax is equal to 3.8% times the lesser
of his dividend income of $40,000 or the amount of his MAGI income in
excess of $200,000 or $10,000. His tax is $380. He would not have owed
any NIIT if he had not withdrawn the $10,000 as this distribution put
his MAGI above his $200,000 threshold level.
There will also be times when a person’s IRA distribution will NOT mean
the individual will have to pay the 3.8% tax on the IRA distribution.
Example. David has wage income of $120,000, he withdraws $25,000 from
his traditional IRA and he has dividend income of $40,000, David’s tax
filing status is single. Since his MAGI, including the IRA distribution
of $25,000, is $185,000 and is less than his threshold of $200,000, the
3.8% net investment income tax is not owed.
There will also be times when a person will take an IRA distribution and
he or she will be required to pay the 3.8% tax, but the amount owed does
not increase because of such IRA distribution. Example. Paula has wage
income of $200,000, she withdraws $40,000 from her traditional IRA and
she has dividend income of $60,000. Paula’s tax filing status is single.
Her MAGI of $300,000 exceeds her threshold level of $200,000. Thus, she
owes the 3.8% tax on the $60,000 of net investment income or $2,280 and
not on the amount in excess of $200,00. She would have owed this $2,280
even if she not withdrawn $40,000 from her traditional IRA.
What types of income are defined to be non-investment income?
Distributions from IRAs, pension plans, 401(k) plans, tax sheltered
annuities, etc. are not investment income. Social security benefits are
not investment income.
Wages and income or profits from a nonpassive business including
self-employment income are not investment income. Unemployment
compensation and workers compensation are not net investment income.
What types of income are net investment income and so they might be
subject to the 3.8% tax?
Investment income includes interest, dividends, gains from the sale of
stocks, bonds, mutual funds, capital gain distributions from mutual
funds, certain sales related to real estate, rental and royalty income,
non-qualified annuities, income from businesses involved in trading of
financial instruments or commodities, business income arising from
certain passive activities, and the sale of an interest in a partnership
and S corporations by an individual who had a passive interest. Such
investment income is reduced by certain expenses properly allocable to
the income. And any income or gain excluded from gross income for
regular income tax purposes is also excluded from a person net
investment income (e.g. $250,000 exclusion for sale of primary
A person will need to take into account taxes owed on account of the net
investment income tax in complying with the estimated tax payment rules.
This net investment income tax also applies to certain trusts and
estates. It does not apply to corporations and other “active”
businesses. It does not apply to trusts associated with IRAs or pension
This new 3.8% Medicare tax (the net investment tax) is different from
the new 9/10ths of 1 percent Additional Medicare tax which also went
into effect on January 1, 2013. An individual is liable for the
additional Medicare Tax if the individual's wages, compensation, or
self-employment income (together with that of his or her spouse if
filing a joint return) exceed the threshold amount for the individual's
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