Speaking of fears of investing, investors may encounter the burden of the 3.8% net investment income tax in addition to many other potential taxes on income. Though the percentage may not seem very high when we consider the top regular income tax brackets, it is important to remember that it is a separate tax stacked on top of federal income tax, state and local income tax (where applicable), not to mention consideration of the other additional costs of investing such as advisory and other professional fees.
Investment income is broadly defined for this tax, including not just interest, dividends, rents, royalties, annuities and gains from the disposition of property but also reaching gross income from a trade or business. The threshold for the imposition of the tax is based on a taxpayer’s modified adjusted gross income – much broader than net investment income, of course – but applies only to the net investment income portion. The threshold for a single taxpayer is $200,000; for married taxpayers filing separately it is $125,000 while married taxpayers filing jointly face a threshold of $250,000. As you can see, the tax will apply to a significant group of taxpayers even if their net investment income is not substantial.
The tax also applies to estates and certain trusts, with some exceptions. Interestingly, the threshold for imposition of the net investment tax is much lower as the top bracket for these entities begins at only $12,950 of income. This is much, much less favorable than the rates for individuals.
The bottom line here is that in addition to other income taxes, the net investment income tax may be applicable to many taxpayers and is a burden not to be ignored. Even where a taxpayer is otherwise entitled to income tax credits, they will not apply to reduce the net investment income tax liability.