What Income Is Subject to the 3.8% Net Investment Tax?
Understand the mechanics of the 3.8% Net Investment Tax, which is determined by both your income level and the specific sources of your investment earnings.
The Net Investment Income Tax (NIIT) is a 3.8% tax on investment income for certain high-income individuals, estates, and trusts. Enacted as part of the Affordable Care Act, this tax applies when a taxpayer’s income surpasses specific thresholds. It functions as an additional tax on top of standard income taxes. The NIIT is calculated on “net investment income,” a figure that includes various investment returns minus certain related deductions.
Who is Subject to the Tax
Whether the Net Investment Income Tax applies is determined by a taxpayer’s Modified Adjusted Gross Income (MAGI). The tax is only a factor for individuals whose MAGI exceeds specific thresholds set by the IRS, which are not indexed for inflation. The thresholds vary by filing status: $250,000 for Married Filing Jointly or a Qualifying Surviving Spouse; $200,000 for Single or Head of Household; and $125,000 for Married Filing Separately.
For NIIT purposes, MAGI is calculated by taking a taxpayer’s Adjusted Gross Income (AGI) and adding back certain foreign-earned income exclusions. If a taxpayer’s MAGI does not exceed their filing status threshold, they are not subject to the NIIT, regardless of their investment income. The tax also applies to certain estates and trusts with undistributed net investment income and an AGI above the dollar amount where the highest tax bracket begins, which is $15,650 for 2025.
Defining Investment Income
Understanding what constitutes investment income is central to the NIIT calculation. The Internal Revenue Service (IRS) provides specific categories of income that are included and excluded, which determines the base for the tax.
Income Included in NII
Gross investment income includes several common types of earnings. Interest from sources like bonds and bank accounts, along with dividends from stocks and mutual funds, are primary components. Capital gains are also included, which are profits from the sale of stocks, bonds, mutual funds, and investment real estate. An exception exists for the sale of a primary residence, where a portion of the gain may be excluded from the NIIT.
Other forms of income subject to the tax include the taxable portion of distributions from non-qualified annuities and royalties from assets like oil and gas rights. A broader category is income from passive business activities. This refers to earnings from a trade or business, such as an S corporation or partnership, in which the taxpayer does not materially participate.
Income Excluded from NII
It is also important to know what is not considered investment income. Wages, salaries, and bonuses from employment are excluded, as is income from a trade or business where the taxpayer is an active participant. This means profits for most small business owners who materially participate in their company are not counted.
Distributions from qualified retirement plans are a major exclusion, so withdrawals from 401(k)s and IRAs are not subject to the tax. Social Security benefits, alimony, and self-employment income are also excluded. Interest from tax-exempt bonds, such as those issued by state and local governments, is not included in the NIIT calculation.
Calculating Your Net Investment Income
After identifying gross investment income, the next step is to calculate the “net” figure by subtracting certain allowable expenses. These deductions must be directly related to the production of that investment income. This process reduces the income base that could be subject to the 3.8% tax.
Common deductions include investment interest expense and state and local income taxes that are allocable to the investment income. For example, if a portion of a state’s income tax is paid on capital gains, that portion can be deducted when calculating NII. The formula is Gross Investment Income minus these deductions equals Net Investment Income (NII). If an individual has $60,000 in investment income and paid $3,000 in state income tax on it, their NII would be $57,000.
The Final Tax Calculation
The final step uses a specific comparison to determine the tax owed. The 3.8% NIIT is not simply applied to a taxpayer’s total Net Investment Income. The law requires a “lesser of” rule, which compares two figures to find the tax base, ensuring the tax is applied to the smaller amount.
The tax is calculated on 3.8% of the lesser of two amounts: (a) the taxpayer’s Net Investment Income (NII) for the year, or (b) the amount by which the taxpayer’s Modified Adjusted Gross Income (MAGI) exceeds the applicable income threshold. The result of this comparison becomes the base to which the 3.8% rate is applied.
To illustrate, consider a single filer with a MAGI of $270,000 and an NII of $90,000. Their MAGI exceeds the $200,000 single filer threshold by $70,000. The tax is applied to the lesser of the NII ($90,000) or the excess MAGI ($70,000). Since $70,000 is the smaller amount, the NIIT owed would be 3.8% of $70,000, which equals $2,660.
In another scenario, a married couple filing jointly has a MAGI of $500,000 and an NII of $100,000. Their MAGI exceeds the $250,000 threshold by $250,000. The tax is applied to the lesser of their NII ($100,000) or the excess MAGI ($250,000). Here, the NII is the smaller figure, so the tax would be 3.8% of $100,000, for a $3,800 liability. This calculation is reported on IRS Form 8960.