Net Investment Income Tax (NIIT)

The Net Investment Income Tax (NIIT), established by the Affordable Care Act, imposes a 3.8% surtax on certain investment income for higher-income taxpayers. The tax applies to individuals with modified adjusted gross income (MAGI) above $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately. These thresholds are not indexed to inflation, meaning more taxpayers may become subject to the NIIT over time.

Net investment income includes interest, dividends, capital gains, rental and royalty income, and income from passive business activities. It does not include wages, self-employment income (which is subject to its own Medicare surtax), Social Security benefits, tax-exempt interest, or distributions from qualified retirement plans like IRAs and 401(k)s. However, retirement distributions can push your MAGI above the threshold, indirectly causing more of your investment income to be subject to the NIIT.

The tax is calculated on the lesser of two amounts: your total net investment income, or the amount by which your MAGI exceeds the applicable threshold. For example, a married couple with $280,000 in MAGI and $50,000 in net investment income would pay the 3.8% tax on $30,000 (the amount by which their MAGI exceeds $250,000), since that is less than their $50,000 of investment income.

Strategies that may help manage NIIT exposure include harvesting investment losses to reduce net investment income, timing the recognition of capital gains, making charitable contributions of appreciated assets, and being mindful of how retirement account distributions and Roth conversions affect MAGI. Municipal bond interest, while tax-exempt for income tax purposes, is not included in net investment income but is included in MAGI for threshold purposes.