Unfortunately, being an American citizen comes with a less pleasant side: taxes. Various types of taxes apply to us, one of which is the Net Investment Income Tax, or NIIT for short. tax that often causes difficulties for American citizens living in Israel. Sometimes it feels like it was designed specifically to complicate our lives and our passive income streams.
So, let’s talk about what this tax entails, explain how it affects our lives here in the Holy Land, and explore how to navigate it, or at least manage it with a little less headache:
What Is NIIT?
The NIIT is essentially a federal tax in the United States (the “U.S.”). Starting on January 1, 2013, it imposes a 3.8% tax rate on the net investment income of individuals, estates, and trusts, provided that the total income exceeds a certain threshold (to be detailed later). The primary purpose of this tax is to help fund the public healthcare system in the U.S. known as “ObamaCare.”
Unlike the federal income tax we’re accustomed to, the NIIT does not apply to all types of income reported on our tax return. In fact, it targets only investment or passive income. Moreover, as mentioned, it doesn’t kick in on the very first dollar earned, and only applies to income above certain levels.
What Makes It Unique for American Citizens Living in Israel?
The NIIT is part of the family of taxes related to Social Security payments (another very common tax in this family is the Self-Employment Tax). What’s unique about American Social Security taxes is that, unlike the regular federal income tax, there are no tax treaties in place to prevent double taxation for dual citizens who hold both American and Israeli citizenships.
In other words, regardless of how much income tax you’ve already paid in Israel, if you have a liability for Social Security taxes—including the NIIT—you must pay this tax in addition to the income tax (Mas Hachnasa) and Social Security (Bituach Leumi)already paid in Israel.
Which Types of Income are Subject to the NIIT?
The NIIT specifically targets investment income—that is, passive income rather than earnings from active work. This includes, among other things, the following types of income:
- Interest and Dividends:
- Interest Income: This can be earned by lending funds to others—such as banks, companies, or governments—as is commonly associated with bank deposits, bonds, or savings plans.
- Dividend Income: This is generated when companies distribute part of their profits to shareholders. Dividend income is relevant not only for investors but also for high-tech employees who receive company stock as part of their compensation package.
- Capital Gains:
Capital gains arise when you sell a financial asset—such as stocks, mutual funds, cryptocurrencies, or a tangible asset like investment real estate—for more than its purchase price.
Another relevant example is high-tech employees who receive company stocks as part of their compensation package and hold onto it for a period during which the stocks’ value increases, rather than selling immediately. - Rental Income from Investment Properties:
When renting a property, the income for tax purposes is the net income—that is, after deducting expenses related to the property such as maintenance, insurance, mortgage interest, depreciation, and property taxes. For instance, if someone earns $30,000 in rental income from a property in Israel but incurs $10,000 in expenses for maintenance and interest, only $20,000 will be considered taxable investment income.. - Income from Royalties and Related Sources
Payments received for copyrights, patents, or other rights are considered passive income. - Income from Trusts or Estates
Trusts and estates can generate income, such as capital gains, interest, and dividends, which is considered as investment income for tax purposes.
Income from Work, Salaries, Bonuses, Active Business Income, or Social Security Benefits
These types of income are not included under the NIIT. In this context, rental income will not be classified as passive if there is active involvement in generating it (for example, through actively managing the property).
So, How Much Do We End Up Paying?
The NIIT applies to U.S. citizens worldwide whose Modified Adjusted Gross Income (MAGI) exceeds the following thresholds:
- $200,000 for individuals who are unmarried and/or U.S. citizens married to non-U.S. citizens, if they have U.S. citizen children included on their tax return (filing statuses: Single or Head of Household).
- $250,000 for married couples filing jointly (Married Filing Jointly status).
- $125,000 for married individuals filing separately; for example, U.S. citizens married to non-U.S. citizens who do not have children or whose children are not U.S. citizens (Married Filing Separately status).
So, How Much Do We End Up Paying?
So, let’s recap what we’ve discussed so far: The NIIT will apply only if the income reported on your U.S. tax return exceeds the threshold ($125,000 / $200,000 / $250,000) and only for investment income (non-active income such as dividends, interest, etc.). In fact, it will be calculated as 3.8% of the lesser of: (1) the total net investment income, or (2) the amount by which the MAGI exceeds the relevant NIIT threshold.
Let’s have a look with an actual example:
Consider a single American citizen residing in Israel with a Modified Adjusted Gross Income of $220,000, of which $50,000 is investment income. The NIIT will apply to the amount of $20,000—the lesser of the $50,000 in passive income or the $20,000 excess of the MAGI over the $200,000 threshold. With the NIIT rate at 3.8%, the total tax liability would be calculated as follows:
$20,000 × 3.8% = $760
A Note on Tax Treaties and Credits
As discussed earlier, unlike regular income tax, in which we benefit from a tax treaty between Israel and the U.S. designed to prevent double taxation, no such treaty exists for Social Security taxes. This means that taxes paid in Israel cannot be credited against the NIIT liability. For example, an American citizen who earns capital gains and pays capital gains tax in Israel will still be liable for NIIT in the U.S. if their income exceeds the NIIT threshold. There is no option to claim a credit for the NIIT, regardless of the U.S. tax rate or the amount of tax paid in Israel (see below for ongoing tax court cases in this regard).
Proper Tax Planning Can Help Reduce or Even Avoid Paying The NIIT!
Please note that several rulings in U.S. courts address the ability to credit foreign taxes against the NIIT, and significant changes in how the NIIT is applied may be on the horizon.
Frequently Asked Questions
- How can investment-related taxes paid in Israel be offset to reduce NIIT liability in the U.S.?
One way to reduce the net investment income subject to the NIIT is by deducting allowable expenses against that income, such as management fees, legal costs, or maintenance expenses on real estate properties.
Another strategy is to engage in tax planning to manage capital gains, so that the gains in any given year do not push total income above the NIIT threshold. For example, a married U.S. couple with an earned income of $220,000 might choose to realize only up to $30,000 in capital gains from their securities portfolio in a single year, ensuring that their overall income remains below the $250,000 threshold for NIIT liability.
- Does the NIIT apply to income that is tax-exempt in Israel?
Exemptions that exist under Israeli tax law are not necessarily recognized by the U.S. and may be deemed taxable under U.S. law, and thus, may be subject to NIIT (if the relevant conditions are met). For instance, in Israel, certain types of income (such as rental income from a primary residence up to a specific limit) may be partially or fully exempt from tax. However, U.S. tax authorities do not acknowledge these exemptions. Conversely, note that some income types are tax-exempt in the U.S., such as gains within American pension accounts.
- Which forms must be filed with the IRS to report income subject to the NIIT?
Income subject to the NIIT is reported as part of the annual tax return on Form 1040, where all sources of income, including investment income, are declared. The NIIT itself is calculated using a dedicated form, Form 8960, where you must detail the types of income subject to the tax (such as interest, dividends, capital gains, rental income, and other forms of passive income). This form is used to determine whether your total income exceeds the NIIT threshold and, if so, to calculate your actual tax liability.
- What are the consequences of failing to accurately report or timely pay the NIIT for U.S. citizens living in Israel?
Failure to accurately report or pay the NIIT on time can lead to financial penalties. Fines may reach up to 25% of the unpaid tax liability, and interest on the unpaid balance “will accrue over time—further increasing your total liability.