Starting in January, a new 3.8% tax on certain investment income will go into effect. This new tax is expected to generate billions to fund the new health care reform and the Medicare plans.
What exactly is "unearned" net investment income?
The income that an individual derives from investing capital which includes capital gains, rents, dividends, and interest income. Additionally, some investments in active businesses (if the investor is not an active participant in the business) will also be subject to the tax.
This new tax will not apply to all real estate transactions. This tax has complex guidelines, but basically outlines that most individuals with an adjusted gross income of $200,000 or above, and couples filing a joint return with more that $250,000 can expect a 3.8% tax on income from interest, dividends, rents, and capital gains. Keep in mind this tax applies only to investment income above the threshold. The tax will also apply to trusts and estates with net investment income of more than $12,000 that is not paid out to heirs or beneficiaries.
Net investment income that is subject to the 3.8% tax
- Net gains from property held for investment (including the taxable portion of gains from the sale of personal residences).
- Gross income from dividends.
- Gross income form interest.
- Gross income from rental activities.
- Gross income from royalties.
- Gross income from annuities.
- Gross income from passive business activities.
- Gross income from the business of trading in financial instruments or commodities.
- Exception for Business Activities - Income from the first 6 categories is generally not taken into account if the income is from a business activity)
- Exception to the Exception - Income from the first 6 categories is taken into account if it is from a passive business activity such as net gains from selling rental properties and net gains from selling passive investments in partnerships and S corporations.
- Exception for distributions from Tax-Favored Retirement Plans- Tax-Favored Retirement Plans and accounts such as 401(k) plans, pension plans, traditional IRAs, and Roth IRAs are excluded from the new tax.
- Income Threshold and Tax Base - The new 3.8% tax will not apply unless your modified adjusted gross income exceeds: (a) $200,000-individual, (b) $250,000 for joint, or (c) $125,000 for those who use married filing separate status.