What Is the Net Investment Income Tax (NIIT)?

The Net Investment Income Tax (NIIT) is a 3.8 percent tax on certain investment earnings for individuals, estates, and trusts with income above specified levels. This tax is levied in addition to any regular income taxes owed on the same income. It was established under Internal Revenue Code Section 1411 as part of the Health Care and Education Reconciliation Act of 2010 to help fund healthcare initiatives. The NIIT is a distinct calculation affecting only those with both investment income and total income exceeding statutory amounts.

Who is Subject to the NIIT

A taxpayer is liable for the NIIT if they have net investment income and their Modified Adjusted Gross Income (MAGI) exceeds the threshold for their filing status. Both conditions must be met. If a taxpayer’s MAGI is below the threshold or they have no net investment income, the tax does not apply.

The MAGI thresholds are fixed by statute and do not adjust for inflation. For individuals who are married and file a joint return or are a qualifying surviving spouse, the threshold is $250,000. A single individual or a person filing as head of household becomes subject to the tax if their MAGI exceeds $200,000. For those who are married but file separate returns, the threshold is set at $125,000.

For NIIT purposes, MAGI is the Adjusted Gross Income (AGI) from Form 1040, increased by any foreign-earned income that was excluded from gross income. Estates and trusts are also subject to the NIIT, with a threshold tied to the dollar amount where their highest tax bracket begins.

Identifying Net Investment Income

Net investment income is calculated by adding specific types of income and then subtracting certain deductible expenses directly related to generating that income. This net figure is what is ultimately used in the NIIT calculation.

Income Included in NIIT

Several categories of income are included when calculating net investment income:

• Interest, dividends, and certain annuities not derived from an active trade or business
• Royalties and rents not earned in an active trade or business
• Net gains from the sale of property, such as stocks, bonds, mutual funds, and investment real estate
• Income from a business considered a passive activity under IRS rules in Section 469
• Income from the business of trading in financial instruments or commodities

Income Excluded from NIIT

The NIIT does not apply to all income. Excluded sources include:

• Wages, salaries, and unemployment compensation
• Income from a trade or business in which the taxpayer actively participates
• Distributions from qualified retirement plans like 401(k)s, traditional IRAs, and most pensions
• Social Security benefits
• Tax-exempt interest, such as from municipal bonds
• The portion of gain from the sale of a principal residence that is excluded from gross income

How to Calculate the Tax Liability

The tax is 3.8 percent of the lesser of two amounts: the taxpayer’s total net investment income, or the amount by which the taxpayer’s MAGI surpasses their filing status threshold. This rule means the tax base can never be larger than the total net investment income.

To illustrate, consider a single filer with a MAGI of $270,000 and net investment income of $90,000. The MAGI threshold for a single filer is $200,000. First, calculate the excess MAGI, which is $270,000 minus $200,000, resulting in $70,000. The tax is then calculated on the lesser of the $90,000 of net investment income or the $70,000 of excess MAGI. The final tax liability would be 3.8 percent of $70,000, which equals $2,660.

The NIIT is calculated and reported on IRS Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts. On this form, taxpayers list their investment income and applicable deductions to determine their net investment income. The form then guides the calculation, and the final tax amount is carried over to Form 1040.

Methods for Paying the NIIT

Payment of the NIIT is integrated into the regular income tax system. Because the U.S. tax system is pay-as-you-go, taxes must be paid throughout the year as income is earned. Taxpayers cannot wait until filing their annual return to pay the full amount without facing a potential penalty.

One method for paying the tax is to make quarterly estimated tax payments using Form 1040-ES, Estimated Tax for Individuals. This is a common approach for taxpayers who have significant income from sources not subject to withholding, such as capital gains or rental income. They must project their total tax liability for the year, including the NIIT, and pay it in four installments.

Another way to cover the NIIT is by increasing tax withholding from other income sources. A taxpayer can submit a revised Form W-4, Employee’s Withholding Certificate, to their employer to request more federal income tax be withheld from paychecks. Taxpayers should ensure they have paid enough tax throughout the year, through either withholding or estimated payments, to avoid an underpayment penalty.