Net Investment Income and Additional Medicare Tax: Everything You Need to Know

In addition to the standard Medicare tax of 1.45% (or 2.9% for self-employed individuals), high-income earners may also be subject to the Medicare Surtax, or Net Investment Income Tax (NIIT), and the Additional Medicare Tax, depending upon their income thresholds.  

Let’s take a closer look at what these taxes are, who they affect, and how you can potentially reduce their impact. 

Net Investment Income Tax 

 What is it? 

 In 2010, the NIIT was developed to help fund healthcare reform as part of the Healthcare and Education Reconciliation Act. It’s a 3.8% surtax on income from investments, including interest, dividends, and capital gains, as well as rental and royalty income and some types of annuity payments.¹ 

 Who does it impact? 

 The NIIT applies to taxpayers with income above certain thresholds: 

How is NIIT calculated? 

The NIIT is calculated as 3.8% of the lesser of:  

• Your net investment income, or  

• The amount by which your modified adjusted gross income (MAGI) exceeds the threshold 

For example, imagine you’re a single taxpayer with a MAGI of $250,000 and a net investment income of $40,000. 

• Your threshold is $200,000 

• Your MAGI exceeds the threshold by $50,000 ($250,000 – $200,000) 

• Your net investment income is $40,000 

The NIIT applies to the lesser of these two amounts: $40,000. Therefore, your NIIT will be 3.8% of $40,000, which is $1,520. 

Note that you’re not paying the tax on your full income, only on the portion that qualifies as net investment income, and only because your MAGI exceeded the threshold. 

Strategies for Reducing NIIT: 

 The Net Investment Income Tax can be a burden for retirees who rely on investment income, like pension payments and withdrawals from tax-deferred retirement accounts, to cover living expenses. However, there are a few ways to manage NIIT liability, including: 

• Adjusting your MAGI by maximizing contributions to tax-deferred retirement accounts, using health savings accounts, and taking advantage of Roth IRA conversions in lower-income years. 

• Managing investment income by holding investments for more than a year to qualify for long-term capital gains rates. You can also use tax-loss harvesting to offset gains. 

• Moving high-income-generating investments (like high-yield bonds and dividend-paying stocks) to retirement accounts where the income tax is deferred and sheltered from tax liability. You can then purchase growth stocks with low dividend yield in your brokerage accounts, which don’t generate investment income until they are sold. 

• Strategically timing income and deductions by spreading large capital gains over multiple tax years, and bunching itemized deductions in alternating years. 

• Adding investments that don’t generate taxable income to your portfolio. 

Additional Medicare Tax 

What is it? 

The Additional Medicare Tax was introduced in 2013 as part of the Affordable Care Act to help low-income beneficiaries pay their premiums. It’s an extra 0.9% tax on top of the standard Medicare tax that applies to wages, Railroad Retirement (RRTA) compensation, and self-employment income.² 

 Who does it impact? 

Like the NIIT, the Additional Medicare Tax applies to taxpayers with income above certain thresholds: 

How is the Additional Medicare Tax calculated? 

The Additional Medicare Tax is a bit more straightforward than the NIIT: a flat 0.9% on earnings above the threshold. 

Let’s take another example. Suppose you’re married filing jointly, and your combined wages are $300,000. 

• Your threshold is $250,000 

• Your wages exceed the threshold by $50,000 ($300,000 – $250,000) 

The Additional Medicare Tax applies only to the amount above the threshold: $50,000. Therefore, your Additional Medicare Tax would be: 0.9% of $50,000, which is $450. 

Again, you’re not paying the additional tax on your full income, only on the portion above the threshold. 

Strategies for Reducing the Additional Medicare Tax: 

Taxpayers can take a few approaches to lowering the Additional Medicare Tax liability, including: 

• Managing earned income by deferring bonuses or additional compensation to lower-income years.  

• Adjusting filing status, as married filing separately could result in a lower overall tax liability than married filing jointly. 

• Adjusting withholdings to ensure employers are withholding enough to cover the Additional Medicare Tax. 

Remember, tax laws and regulations change frequently, and your tax bracket and financial situation can also evolve. We recommend working with a financial professional to employ the right tax-mitigating strategies for your circumstances. If you’d like to learn more, get in touch with our team here! 

Sources:
¹https://www.forbes.com/advisor/investing/net-investment-income-tax/ 

²What Is the Additional Medicare Tax? Who Pays & Tax Rate (retireguide.com)