NIIT
The Net Investment Income Tax (NIIT) is a 3.8% federal surtax under §1411 imposed on the lesser of (a) net investment income or (b) the excess of modified adjusted gross income over a threshold ($200,000 for single, $250,000 for married filing jointly, $125,000 for married filing separately). The thresholds are NOT indexed for inflation — the 'high earner' definition has compressed every year since 2013.
NIIT was enacted by the Affordable Care Act in 2013 to fund Medicare expansion. The unindexed thresholds have made it a structural surtax on a steadily larger fraction of taxpayers — what was 'top earner' territory in 2013 is now upper-middle in real terms. By 2025, roughly 8 million returns owe some NIIT annually, up from ~3 million at enactment.
Net investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuity distributions, and income from passive activities (including most K-1 income from limited-partnership interests where the taxpayer doesn't materially participate). It excludes wages, active business income, retirement-account distributions, Social Security, and tax-exempt interest. The 'net' is gross investment income minus properly allocable deductions (investment management fees, investment interest, state income tax allocable to investment income).
The threshold mechanic is critical. NIIT applies to the smaller of net investment income or the MAGI excess. A taxpayer with $50,000 of net investment income and MAGI exactly at the threshold owes zero NIIT — even with substantial investment income, the MAGI excess is zero. A taxpayer just $20,000 over the threshold with $50,000 of net investment income owes 3.8% × $20,000 = $760, not 3.8% × $50,000. This makes NIIT a marginal-rate-sensitive tax: the planning lever is suppressing MAGI below the threshold (Roth-status saving, QCDs from IRAs, capital-loss harvesting) to clip the NIIT entirely.
NIIT = 3.8% × min(NII, MAGI − threshold)- NII
- = net investment income (gross investment income minus allocable deductions)
- MAGI
- = modified adjusted gross income
- threshold
- = $200k single / $250k MFJ / $125k MFS (NOT indexed)
MFJ NII=$200k, MAGI=$600k, threshold=$250k. min(200k, 350k) = 200k. NIIT = 3.8% × 200k = $7,600.Synthetic households across the high-earner segment should compute NIIT correctly: identifying which categories of income are NII vs. excluded, computing the MAGI excess, taking the lesser. Edge cases include: state-tax-allocation-against-NII deductions, married-filing-separately's lower $125k threshold, and the interaction between NIIT and the regular capital-gains rate (a 23.8% all-in federal rate on top long-term gains).
Common pitfalls
- Counting wages as investment income — wages are explicitly excluded, but high-earner W-2 + dividends households often confuse the pieces.
- Treating all K-1 income as NII — only passive K-1 income is NII; active K-1 from material participation is excluded.
- Forgetting the deductibility of properly allocable expenses — investment management fees, margin interest, state tax on investment income reduce the NII base.
- Computing NIIT on the gross investment income amount instead of the lesser of NII vs. MAGI excess — the lesser-of rule is the actual computation.
Examples
MFJ couple with $400,000 W-2 income, $80,000 of qualified dividends, $120,000 of long-term capital gain. MAGI: $600,000. MAGI excess over $250,000: $350,000. Net investment income: $200,000 (dividends + cap gain). NIIT: 3.8% × min($200,000, $350,000) = 3.8% × $200,000 = $7,600. All-in federal rate on the LT capital gain: 20% + 3.8% = 23.8%.