Net Investment Income Tax: Who Pays and How It’s Calculated

The Net Investment Income Tax (NIIT) is a 3.8% tax applied to certain investment earnings for higher-income taxpayers. This tax was established as part of the Health Care and Education Reconciliation Act of 2010, which is part of what is commonly known as the Affordable Care Act (ACA). The tax became effective on January 1, 2013, and was intended to help fund healthcare reform initiatives.

The NIIT is a surtax, meaning it is levied in addition to other taxes you might already pay, such as capital gains or income tax. It applies to individuals, estates, and trusts that have both net investment income and income exceeding certain statutory thresholds. It is a distinct tax, separate from other levies like the Additional Medicare Tax, which also originated from the same legislation.

Determining if You Are Subject to the NIIT

The tax is triggered only when your Modified Adjusted Gross Income (MAGI) surpasses specific thresholds set by the Internal Revenue Service (IRS). These income thresholds are fixed and do not adjust for inflation, meaning more taxpayers may become subject to the tax over time as incomes rise. If your MAGI is below the applicable threshold for your filing status, you will not owe the NIIT, regardless of how much investment income you have.

For NIIT purposes, MAGI is calculated by starting with your Adjusted Gross Income (AGI), which is found on your Form 1040, and adding back certain deductions related to foreign-earned income. For most taxpayers without foreign income, their MAGI will be the same as their AGI. It is this MAGI figure that you must compare against the established thresholds to see if you are potentially liable for the tax.

The MAGI thresholds depend on your tax filing status. For those who are Married Filing Jointly or a Qualifying Widow(er), the threshold is $250,000. For individuals with a Single or Head of Household filing status, the threshold is $200,000. The threshold is lowest for those who are Married Filing Separately, set at $125,000.

Identifying Your Net Investment Income

Once you determine your income is above the required threshold, the next step is to identify what counts as net investment income. This category is broadly defined and captures many common types of earnings from capital assets. The calculation requires summing up various sources of gross investment income and then subtracting specific, allowable expenses to arrive at the “net” figure used for the tax computation.

Income Included

Several categories of income fall under the NIIT umbrella. These include interest, dividends, and non-qualified annuities that are taxable. Capital gains from the sale of property, such as stocks, bonds, and mutual funds, are also included, and income from transactions involving digital assets may also be subject to the NIIT. This extends to gains from the sale of a main home that exceed the home sale exclusion amount, which is $250,000 for single filers and $500,000 for joint filers.

Rental and royalty income are considered investment income. Income derived from a business is also included if it is a passive activity for the taxpayer or if the business involves trading in financial instruments or commodities. A passive activity is any rental activity or a trade or business in which you do not materially participate.

Income Excluded

The tax does not apply to wages, salaries, or unemployment compensation. It also excludes operating income from a nonpassive business, which is a trade or business in which you materially participate. Social Security benefits and alimony payments are not considered investment income.

This includes tax-exempt interest, such as that earned from municipal bonds. Distributions from most tax-preferred retirement accounts, like traditional IRAs, 401(k)s, 403(b)s, and 457(b) plans, are not subject to the NIIT. An exception exists for real estate professionals who demonstrate material participation in their rental real estate activities, which may allow their rental income to be classified as nonpassive and excluded from the NIIT.

Calculating the Tax Liability

After confirming you are subject to the NIIT, the final step is to calculate the actual tax amount. The tax rate is a flat 3.8%, but it is only applied to a portion of your income. The NIIT is 3.8% of the lesser of two amounts: your total net investment income or the excess of your Modified Adjusted Gross Income (MAGI) over the income threshold for your filing status.

You will compare these two figures and apply the 3.8% tax rate to whichever one is smaller. Consider a single individual with a MAGI of $220,000 and net investment income of $30,000. The MAGI of $220,000 is over the $200,000 threshold for single filers, creating an excess MAGI of $20,000.

The tax is calculated on the lesser of the net investment income ($30,000) or the excess MAGI ($20,000). In this case, the tax would be 3.8% of $20,000, resulting in an NIIT liability of $760.

Reporting and Paying the NIIT

Your NIIT liability is calculated and reported on IRS Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts. This form walks you through the calculation, from determining your MAGI and investment income to applying the thresholds and calculating the final tax. The result from Form 8960 is then carried over to your main tax return, Form 1040, and added to your total tax liability for the year.

To avoid potential penalties, you can pay the NIIT in two ways. If you are an employee, you can increase your income tax withholding from your paychecks by submitting a revised Form W-4, Employee’s Withholding Certificate, to your employer. You cannot request specific withholding for the NIIT, but you can request additional withholding to cover the liability.

Alternatively, or if you are self-employed, you can make quarterly estimated tax payments using Form 1040-ES, Estimated Tax for Individuals. You would include the anticipated NIIT amount in your total estimated tax calculation for the year and pay it in four installments.