Definition and Examples of the Net Investment Income Tax
The net investment income tax is a 3.8% tax on investment income that typically applies only to high-income taxpayers. It applies to individuals, families, estates, and trusts, but certain income thresholds must be met before the tax takes effect.
- Acronym: NIIT
Net investment income can be capital gains, interest, or dividends. It can include income produced by rental properties, capital gain distributions from mutual funds, and even royalty or annuity income and interest on loans you might have extended to others.
It includes the income derived from a trade or business that is classified as passive income and income from business trading financial instruments or commodities.
How the Net Investment Income Tax Works
When a taxpayer sells pretty much any type of investment, they'll realize either a gain or a loss—they'll make money or they'll lose money if they sell for less than what they have invested in the asset. But there are some exceptions.
Tax-exempt state interest is not included in net investment income. Gains realized from the sale of a principal residence are spared when the gain is excluded from income for income tax purposes. Gains on property held in a trade or business are also exempt.
Net investment income does not include wages, self-employment income, unemployment compensation, Social Security benefits, or alimony.
How the Net Investment Income Tax Developed
The net investment income tax was legislated as part of the Health Care and Education Reconciliation Act of 2010, which went effect in March 2010. The net investment tax, however, went into effect on Jan. 1, 2013.
The net investment income tax was included as part of that legislation to raise revenue. The Joint Committee on Taxation estimated that the tax would generate $36.6 billion in tax revenue in tax year 2021.
The official name of the net investment income tax is under a program known as the "Unearned Income Medicare Contribution." This suggests that the tax revenue is used to fund Medicare, but the revenue raised by this tax actually goes into the nation's general fund. In fact, you can be subject to the net investment income tax even if you're exempt from the Additional Medicare tax because these two taxes apply to different types of income.
Do I Need to Pay the Net Investment Income Tax?
The net investment income tax thresholds are based on your filing status and income. You are likely subject to this tax if you have investment income and your modified adjusted gross income exceeds certain thresholds.
|Filing Status||Income Threshold|
|Single or head of household||$200,000|
|Married filing jointly||$250,000|
|Married filing separately||$125,000|
|Qualified widow(er) with a child||$250,000|
This tax is paid in addition to your income tax obligation. It's also over and above what you paid into Medicare through withholding from your earned income or estimated tax payments. But you're only subject to this tax if you have net investment income and your MAGI exceeds these thresholds.
The net investment income tax is imposed on estates and trusts, as well as individuals.
For individuals, it applies to U.S. citizens and resident aliens. It does not apply to non-resident aliens unless they've elected to be treated as a resident of the U.S. for tax purposes so they can file joint married tax returns.
The net investment income tax applies to estates and trusts when they have net investment income and have adjusted gross incomes for the year exceed the dollar amount at which the highest tax bracket begins.
Grantor trusts and trusts that are exempt from income taxes, such as charitable remainder trusts, are exempt from the net investment income tax. In most cases, taxes on grantor trusts are payable by the individual—the grantor—who formed and maintains them.
How Do I Pay the Net Investment Income Tax?
File IRS Form 8960 with your tax return if you're subject to the net investment income tax. The form comes complete with instructions to help you determine what you owe, and it should be used by both individuals and estates or trusts.
Keep in mind that if you owe this tax, you will need to make quarterly estimated payments on the amount you think you'll owe in addition to any quarterly income payments.
Calculate Your MAGI
Your IRS Form 1040 can help you calculate your net investment income tax. First, calculate your MAGI. Start with your adjusted gross income (see line 11 of your Form 1040).
Second, add back certain deductions, including:
- The foreign earned income exclusion
- Foreign housing costs
This number is your modified adjusted gross income for net investment income tax, which may be slightly different from your MAGI for other tax calculations.
You can use the MAGI worksheet included on page 19 in the instructions for Form 8960 to calculate your MAGI for the net investment income tax.
If your net investment income is less than the portion of your MAGI over the tax thresholds, you would pay 3.8% of this amount instead. Next, you have to compare your MAGI to your net investment income for the year.
Account for Deductions
Remember, this is net income. Trade commissions or fees are deducted from your realized amount of gain. You can subtract your expenses from your total realized gain, including costs you incurred to maintain these investments such as tax preparation fees.
Other deductions that can reduce net investment income include:
- Deductions related to producing rental and royalty income
- Deductions related to producing business income for a trade or business that is a passive activity or trades in financial instruments or commodities
- Investment interest expenses
- Brokerage fees
- The portion of state income tax that relates to net investment income
- Casualty and theft losses related to property that was sold or disposed
Some of these deductions are already included in the investment income figures. For example, rental income, royalty income, business income, and net capital gains will already be a net amount after deductions or losses have been taken into account.
Other deductions, however, are not included in these net figures, so they must be deducted against investment income to arrive at net investment income. These separate deductions include the penalty on early withdrawal of savings, investment interest, investment expenses, state income tax allocated to investment income, and casualty and theft losses related to investment property.
Calculate Your Net Investment Income Tax Liability
The net investment income tax is due on the lesser of your undistributed net investment income or the portion of your MAGI that exceeds the thresholds.
Multiply the lower number by 0.038 (3.8%). This is the amount of net investment income tax you will pay.
- The net investment income tax (NIIT) is a 3.8% tax on net investment income, such as capital gains, dividends, and rental and other income after allowable deductions, to the extent the net amount exceeds a threshold.
- This tax only applies to high-income taxpayers, such as single filers whose MAGI exceeds $200,000 and married couples whose MAGI exceeds $250,000, as well as certain estates and trusts.
- This tax was created to help fund Medicare expansion, but the revenue technically goes into the general fund.
IRS. "Topic No. 559 Net Investment Income Tax." Accessed Jan. 31, 2022.
Internal Revenue Service. "Questions and Answers On the Net Investment Income Tax." Accessed Jan. 31, 2022.
Congress.gov. "H.R.4872—Health Care and Education Reconciliation Act of 2010." Accessed Jan. 31, 2022.
Congressional Research Service. "Medicare: Changes Made by the Reconciliation Act of 2010 to the Patient Protection and Affordable Care Act," Pages 8-9. Accessed Jan. 31, 2022.
IRS. "Find Out if Net Investment Income Tax Applies to You." Accessed Jan. 31, 2022.
Joint Committee on Taxation. "Overview of the Federal Tax System as in Effect for 2021," Page 9. Jan. 31, 2022.
Office of the Law Revision Counsel. "Chapter 2A—Unearned Income Medicare Contribution." Accessed Jan. 31, 2022.
Asena Advisors. "Net Investment Income Tax (NIIT)." Accessed Jan. 31, 2022.
Internal Revenue Service. "Find Out If Net Investment Income Tax Applies to You." Accessed Jan. 31, 2022.
IRS. "2021 Instructions for Form 8960," Page 19. Accessed Jan. 31, 2022.
IRS. "Instructions for Form 8960." Accessed Jan. 31, 2022.
IRS. "Topic No. 515: Casualty, Disaster, and Theft Losses." Accessed Jan. 31, 2022.