If you have a high income, there are additional taxes that may apply to you. To stay informed and up to date on the tax code, we are going to go into depth on two additional taxes that you might be subject to: the 3.8% Net Investment Income Tax (NIIT) and the 0.9% Additional Medicare Tax on wage and self-employment income. Let’s take a look at these taxes and what they could mean for you.
1. The NIIT
In addition to income tax, the NIIT applies to your net investment income. This tax affects taxpayers with adjusted gross incomes (AGIs) exceeding $250,000 for joint filers, $200,000 for single taxpayers and heads of household, and $125,000 for married individuals filing separately.
If your AGI surpasses the applicable threshold that applies ($250,000, $200,000 or $125,000), the NIIT applies to the lesser of 1) your net investment income for the tax year or 2) the amount by which your AGI exceeds your threshold.
“Net investment income” subject to the NIIT includes interest, dividends, annuities, royalties, rents, and net gains from property sales. Wage income and income from an active trade or business are not included. However, passive business income is subject to the NIIT.
Income that is exempt from income tax, such as tax-exempt bond interest, is also exempt from the NIIT. Therefore, switching some taxable investments to tax-exempt bonds can reduce your exposure. Of course, this should be done after considering your income needs and investment goals.
Does the NIIT apply to home sales? Yes, if the gain is significant. Here is how the rules work: If you sell your principal residence, you may be able to exclude up to $250,000 of gain ($500,000 for joint filers) from your income tax calculation. This excluded gain is not subject to the NIIT.
However, gain that exceeds the exclusion limit is subject to the tax. Gain from the sale of a vacation home or other second residence, which does not qualify for the exclusion, is also subject to the NIIT.
Distributions from qualified retirement plans, such as pension plans and IRAs, are not subject to the NIIT. However, these distributions may push your AGI over the threshold, potentially subjecting other types of income to be taxed.
2. The additional Medicare tax
In addition to the 1.45% Medicare tax that all wage earners pay, some high-wage earners are subject to an extra 0.9% Medicare tax on a portion of their earnings. The 0.9% tax applies to wages exceeding $250,000 for joint filers, $125,000 for married individuals filing separately and $200,000 for all others. This additional tax only applies to employees, not to employers.
Once an employee’s wages reach $200,000 for the year, the employer is required to start withholding the additional 0.9% tax. However, this withholding may not be sufficient if the employee has additional wage income from another job or if the employee’s spouse also has wage income. To avoid that result, an employee may request extra income tax withholding by filing a new Form W-4 with the employer.
An extra 0.9% Medicare tax also applies to self-employment income for the tax year in excess of the same amounts for high-wage earners. This is in addition to the regular 2.9% Medicare tax on all self-employment income. The $250,000, $125,000, and $200,000 thresholds are reduced by the taxpayer’s wage income.
Mitigate the effect
As you can see, these two taxes may have a substantial impact on your tax bill. Contact us to discuss strategies for minimizing their effects.
