Back in 2013, as part of the Affordable Care Act’s effort to shore up Medicare, Congress passed the Net Investment Income Tax (NIIT, pronounced “nit”), a 3.8 percent tax on investment income (interest, stock dividends, capital gains) of those with incomes above $250,000, which, by the way, is the top 3 percent of households, according to the Census Bureau. At the same time, a 0.9 percent surtax on the earnings of high-income taxpayers (again, above $250,000) was added to the 2.9 percent Medicare tax already in place on wages and self-employment earnings, bringing that tax up to 3.8 percent as well.
So far, so good, and the NIIT has mostly been working as intended; along with other reforms discussed below, Medicare’s finances are in better shape because of it. But a problem with the NIIT has surfaced: A large share of income from pass-through businesses is not being taxed by the NIIT. For reasons having to do with their special status in the tax code, business income for “S-corporations,” LLCs and limited partnerships (basically, businesses that are not structured as standard corporate entities) claimed by the wealthiest taxpayers is escaping the NIIT. That’s costing the Treasury $200 billion over 10 years, which even in D.C. is real money.
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