The net investment income tax (NIIT) is an additional 3.8% tax on top of your regular income tax. It applies to investment income like dividends and interest. This tax can impact any taxpayer with income above thresholds assigned by the IRS to each filing status. The applicability threshold for NIIT is $250,000 for married taxpayers filing a joint return, $200,000 for single/head of household filers, and $125,000 for married taxpayers filing separate returns.
Key Takeaways:
- The NIIT is also known as the unearned income Medicare contribution surtax, not to be confused with the 0.9% additional Medicare tax, discussed later.
- The NIIT applies to investment income like interest, dividends, most capital gains, and rent and royalty income.
- Trade or business income is excluded from NIIT.
- Your NIIT is reported on IRS Form 8960, which will be included and filed with your personal tax return.
How the Net Investment Income Tax Works
Your NIIT calculation starts with your adjusted gross income (AGI), which can be found on IRS Form 1040, line 11. To pinpoint the amount of income exposed to this 3.8% tax, identify the two figures below, then select the smallest of the two options.
- Your net investment income (your NII consists of your gross investment income less costs incurred in obtaining that income); or
- The difference between your AGI and the threshold amount shown below (based on your filing status):
- Married filing jointly: $250,000
- Single/Head of Household: $200,000
- Married filing separately: $125,000
In arriving at NII, you are only permitted to deduct expenses from your gross investment income that are deductible for purposes of regular income tax.
What’s Taxable as NII
In general, NII is the income one receives from investments, not income received through active earnings.
Examples of NII are as follows:
- Interest or dividends
- Capital gains (apart from certain excluded gains from the sale of a principal residence)
- Rental and royalty income
- Annuities
The following are not generally classified as components of NII, but they are included in the calculation of AGI:
- Wages
- Income from self-employment/active trade or business
- Unemployment compensation
- Social security benefits
- Alimony
- Retirement plan distributions (e.g., IRA and 401k withdrawals)
- Tax-exempt investment income
- Like-kind exchanges
Example of Net Investment Income Tax
Joe and Jessica Richardson are married and file a joint tax return in 2024. Here is how the NIIT would apply to them, given the income detailed below:
The Richardsons have $60,000 more in AGI ($310,000 − $250,000) than the allowable $250,000 threshold for those married filing jointly.
As noted above, the amount on which the tax is assessed is the smaller of the following:
- Net Investment Income: $50,000
- Difference between AGI and the married filing joint threshold amount: $60,000
Since NIIT will be assessed on $50,000 since that is the smaller amount, the Richardsons’ 2024 NIIT is $1,900 ($50,000 × 3.8%). If Joe and Jessica had AGI of $245,000, they would not be subject to the NIIT—even with $50,000 of NII—because their AGI is under the $250,000 threshold for their filing status.
Net Investment Income Tax Planning Considerations for Home Sales
NIIT rules can sometimes apply in unexpected places. Be aware of the NIIT impact if either of these situations applies to you.
Sale of Personal Residence
The IRS allows for an exclusion of gain on sale of a main home if certain criteria are met. The exclusion is up to $250,000 for single filers and $500,000 for married taxpayers filing a joint tax return. Both income tax and NIIT apply to gains in excess of the exclusion. This can be an unexpected tax hit that taxpayers may face when selling an appreciated primary residence.
Sale of Second Home
For purposes of the NIIT, the IRS considers a vacation home to be an investment and subject to NIIT. This situation could give rise to two tax surprises given that the gain exclusion previously referenced is only applicable to a taxpayer’s primary residence. Some taxpayers may not expect for the gain on the sale of their second home to be both fully taxable and subject to NIIT.
Net Investment Income Tax vs Additional Medicare Tax
Taxpayers with large amounts of earned income and investment income might find themselves subject to both the NIIT and the additional Medicare tax.
In general, most individuals pay a 1.45% Medicare tax on all wages and self-employment income. Taxpayers with wages and/or self-employment income that exceed the thresholds below are subject to an additional Medicare tax of 0.9%.
- Married filing jointly: $250,000
- Single/Head of Household: $200,000
- Married filing separately: $125,000
Note that while the threshold amounts are the same for both NIIT and the additional Medicare tax, the thresholds are for different tax components.
- For NIIT, the thresholds are applied to AGI.
- For additional Medicare tax, the thresholds are applied to wages and self-employment income.
Example of NIIT & Additional Medicare Tax Combined
Connor Cash, a single taxpayer, has the following tax situation for 2024:
- Net investment income: $35,000
- Wage income: $275,000
- Adjusted gross income: $310,000
In addition to his standard federal and state income tax, Connor will be subject to the following additional taxes:
- Net investment income tax: $1,330 ($35,000 × 0.038)
- Additional Medicare tax: $675 ($75,000 ($275,000 − $200,000 = $75,000) × 0.009)
In calculating his NIIT, Connor based his calculation on the smaller of $35,000 (NII) or $110,000 (AGI excess; $310,000 − $200,000) and used the lower $35,000 figure to arrive at $1,330 in NIIT.
The standard 1.45% of Medicare tax will be withheld from Connor’s wages throughout the year by his employer. The additional Medicare tax, seen above, was calculated by first determining the excess of Connor’s wages over the threshold for single filers and then multiplying that excess by 0.009.
How to Minimize Net Investment Income Tax
As the income threshold amounts for NIIT are not indexed for inflation, increasingly more people will be subject to the tax. There are several ways to structure your investment portfolio to minimize NIIT. Here are a few ways this can be done:
- Invest in tax-exempt bonds. The interest from tax-exempt income is exempt from both income tax and NIIT.
- Invest in growth stocks. Growth stocks that don’t pay out income are not subject to NIIT until they are sold.
- Invest in retirement plans. Initial contributions to traditional retirement plans like IRAs and 401(k) plans can reduce your AGI below the NII threshold. Distributions from qualified retirement plans like IRAs and 401k plans—whether traditional or Roth—are not subject to NIIT. Since the tax on a ROTH IRA is prepaid, the distribution is also not subject to income tax.
- Consider an installment sale to lower AGI. The installment method will reduce the amount of gain recognized in the year of sale, which could lower your income below the NIIT threshold. While any AGI-lowering mechanism could be a strategy to reduce NIIT, a large sale could push someone who is typically not an NIIT candidate into that territory; an installment sale could prevent that from happening.
- Consider substituting the foreign income deduction for the foreign tax credit. Due to qualifying criteria, this may not always be possible. However, the foreign income tax deduction may be used against NIIT, while generally, the foreign tax credit is not permitted as an offset.
Frequently Asked Questions (FAQs)
Most credits can be applied against NIIT. There are others, such as the foreign income tax credit, that cannot be used as an offset unless there is a special allowance, like a tax treaty.
Yes. Non-resident aliens and dual-resident individuals (as defined by the IRS) subject to certain tax treaties are not subject to NIIT. Dual-status individuals who are part-year US residents may be subject to a prorated amount of NIIT.
Depending on the amount, the answer may be yes. Per the IRS Form 8814 instructions, the amount of the child’s investment income picked up on your return is included both for purposes of calculating AGI and your NIIT.
Bottom Line
The NIIT is a health care tax that applies to taxpayers who have AGI of a specific amount set by the IRS and correlated to their filing status. The tax is 3.8% of the lesser of NII or the amount by which the taxpayer’s AGI exceeds the threshold set for their filing status.
