Capital Gains & NIIT Tax
Taxation is complex. We provide below what we believe are the key highlights for this tax type in a 2-3 minute read for reference purposes. It is not tax advice and does not discuss the vast majority of the finer points.
What Are Capital Gains/NIIT Tax? When/How Do They Apply?
Capital Gains Tax
Capital gains tax applies when you sell an asset, like stock shares, for a profit. The taxable amount is the difference between what you paid for the asset (your cost basis) and the amount you sold it for. At the federal level, capital gains can be classified as either short-term or long-term:
Short-term capital gains occur if you owned the asset for one year or less. The tax rate for short-term gains is the same as your ordinary income tax rate.
Long-term capital gains occur if you owned the asset for more than one year. The tax rate for long-term gains is lower, and has its own progressive tax schedule (which is a function of your total income)
Most taxpayers will owe capital gains taxes when they file their tax return for the year in which the gain was realized. However, in certain situations you may need to pay estimated taxes to avoid potential underpayment penalties.
Net Investment Income Tax (NIIT)
The net investment income tax, or NIIT, is an incremental tax of 3.8% that is applied to investment income for higher earning individuals. For single-tax-filers, it applies when income is greater than $200,000; for married-filing-jointly it applies when income is greater than $250,000.
NIIT applies to: interest, dividends, capital gains, rental income, and other investment income.
NIIT does not apply to: wages, unemployment benefits, operating income from a non-passive business, Social Security, or IRA/401(k) distributions.
Like capital gains taxes, the NIIT is reported and paid with your annual income tax return. Like other tax types, NIIT thresholds are subject to annual inflation adjustments.
What Are the Current Tax Rates/Brackets
As of 2023, the current federal rates for capital gains and NIIT are below.
| Tax Rate | Single | Married Filing Jointly |
|---|---|---|
0% | $0 to $44,625 | $0 to $89,250 |
15% | $44,625 to $492,300 | $89,250 to $553,850 |
20% | $492,300 or more | $553,850 |
Note: In additional to federal tax, most states that have an income tax treat capital gains as income and tax it according to their rate schedule. For more details see: State & Local/City Tax
Withholding Requirements
In most cases (but not all) there are no withholding (or estimated tax payment) requirements for capital gains and/or NIIT at the federal level. For state income taxes however, the rules are more complex and withholding/estimated payments may be required in certain income or gain circumstances.
Capital gains taxes are typically reported and paid when you file your annual income tax return. The taxes are calculated based on your capital gains and losses for the tax year.
Similarly, NIIT also does not usually (but may sometimes) require withholding/estimated tax payments, and you calculate your NIIT when filing your annual tax return.
What Types of Stock Compensation Does This Apply To?
| Stock Comp Type | Capital Gains and NIIT Applicability |
|---|---|
ISOs | Depends. No tax at grant. At exercise, no ordinary income is recognized (but AMT may be owed). At sale, if capital gains are realized then capital gains tax would apply, as well as NIIT if income exceeds the threshold. For more info see: ISO Stock Options |
NSOs | Depends. No tax at grant. At exercise, ordinary income is recognized if there is a bargain element. At sale, if capital gains are realized then capital gains tax would apply, as well as NIIT if income exceeds the threshold. For more info see: NSO Stock Options |
RSUs | Depends. RSUs are taxed at vesting (which also sets the cost basis for the shares). At sale, if capital gains are realized then capital gains tax would apply, as well as NIIT if income exceeds the threshold. For more info see: Restricted Stock Units (RSU) |
ESPPs | Partial. Depends on (i) what ESPP plan type it is (Qualified/Non-Qualified plan), and (ii) if a Qualified plan, when the shares were sold. Any increase in share price after the shares are received are generally taxed at capital gains. The lookback benefit may also be as well (if its a qualified plan and a qualifying disposition). For more info see: Employee Stock Purchase Plan (ESPP) |
RSAs | Very Likely. Assuming an 83(b) election was filed upon grant, any additional gains would be have capital gains rates apply (and NIIT if above the threshold). For more info see: Restricted Stock Award (RSA) |
SARs | No. SARs are taxed upon exercise as ordinary income based on the spread between the exercise price and current FMV of the underlying shares. No shares are issued, so no capital gains. For more info see: Stock Appreciation Right (SAR) |
Phantom Stock | No. Phantom stock payouts are taxed as ordinary income. No actual shares are issued, so there is no capital gains treatment. For more info see: Phantom Stock |
Unique Items and Special Situations
Tax Loss Harvesting
Capital losses can offset capital gains on a dollar-for-dollar basis (known as "tax loss harvesting"). Further, the offsetting of capital gains and losses follows specific rules:
First, all short-term capital losses are matched against all short-term capital gains
Second, all long-term capital losses are matched against all long-term capital gains
Last, the net short- and long-term capital gains/losses are matched against each other
For more information see: Tax Loss Harvesting
Capital Losses Above $3,000 Will Carry Forward Into Future Years
If you have a net capital loss in a year, it may be partially utilized, but otherwise will likely carry forward into future years (where it can offset other capital gains). Specifically, up to $3,000 of net capital losses each year can be used as a deduction against your ordinary income. Any excess capital losses above that will be carried forward to the next tax year.
In Rare Situations, You Need to Hold an Investment Longer Than 1 Year to Receive LTCG Status
ISOs have unique tax treatment. Generally, to receive long-term capital gains on ISOs, you must meet two criteria: (i) the ISO grant was made at least 2 years prior to the stock being sold, and (ii) the ISO was exercised at least 1 year prior to the stock being sold. If both requirements are not met, you will have a disqualifying disposition, impacting how it is taxed. For more information see: ISO Taxation
Carried interest refers to the profit interest certain investment managers receive as compensation for managing investment partnerships like private equity, venture capital or hedge funds. Carried interest compensation has preferential treatment (taxed at long-term capital gains rates) if it meets certain criteria; specifically that it was held for 3 years. For more information see: Tax Policy Center: What Is Carried Interest, and How Is It Taxed
There have been proposals to change the tax treatment of carried interest. But as of 2022, it remains taxed as a long-term capital gain.
Some Assets May Have Other Tax Types That Need to Be Considered as Well
Depreciation recapture occurs when you sell real estate that you have taken depreciation deductions on. The depreciation you claimed is taxed as ordinary income up to a maximum rate of 25%, and any profit beyond that is taxed as a capital gain. This can result in paying both ordinary income and capital gains rates on the profitable sale of investment real estate.
Collectible assets like art, antiques, precious metals, and gemstones are generally taxed at a 28% capital gains rate. This special rate applies even if you are in a lower tax bracket.
Owners of S-corporations and other pass-through entities need to consider the impact of capital gains at the entity level and the individual owner level. While the capital gain may be realized when the entity sells an asset, the tax is paid by the individual owners when the profit is passed through. The total tax paid depends on both the individual and entity level rates.
Nonresident aliens are typically exempt from the NIIT. However, non-resident aliens who meet the "substantial presence test" and are treated as resident aliens for tax purposes would be subject to the NIIT.
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