High earning taxpayers are all too familiar with the 3.8% surcharge on unearned income. Under Code Sec. 1411, the unearned income of individuals, trusts and estates can be taxed in addition to any other tax payable on that income. This tax, also referred to as the Net Investment Income Tax (NIIT), is applied as follows:
- Individuals: The NIIT is 3.8% of the lesser of either your net investment income, the excess modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married person filing individually. For any other case it is $200,000).
- Estate or Trust: The surtax is 3.8% of the lesser of undistributed NII or what is left over from adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
- Investment Income: The surcharge tax is only applicable to trade or businesses if it is a Code Sec. 469 passive activity of the taxpayer or a trade or business of trading in Code Sec. 475(e) (2) financial instruments or commodities. If your trade or business is conducted by a sole proprietor, partnership or S corporation, this surtax does not apply to you.
In order to lessen or eliminate the surcharge, taxpayers need to pay close attention to their estimated MAGI and NII for the year. Some may want to consider minimizing (through deferral) the remaining additional NII. Others can look into reducing MAGI outside of unearned income, and some may need to consider ways to minimize both.