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MANY PEOPLE don’t know, but there is a net investment income tax of 3.8% that applies to some of your income. Today, I want to discuss what it is, how we can reduce its impact, and how we can save money.
Let’s dive right in:
Net Investment Income Tax (NIIT)
The net investment income tax is imposed on investment income if the modified adjusted gross income (adjusted gross income + foreign income exclusion) is more than $200,000 for single filers or $250,000 for those married filing jointly.
This tax is applied to the lower of:
Example
Say you have a modified adjusted gross income of $220,000. Your net investment income is $40,000. You are single. How much tax will you pay?
$220,000 – $200,000 = $20,000 (above the threshold)
The amount subject to the tax is the lesser of:
$20,000 * 0.038 = $760 of tax
Common examples of investment income
Note that the NIIT does not apply to:
Now let’s talk about how we can save some money on taxes:
1. Interest
Municipal bond interest (received from a city or state) is tax-exempt. So, if you have a lot of interest income, consider shifting that portion of your portfolio to a municipal bond ETF and avoid the NIIT.
However, you still need to do the math to make sure it’s worth it.
Make sure the yield * (1 – marginal tax rate) is lower than the municipal bond yield. Remember. the goal is not to minimize taxes. The goal is to maximize your after-tax return.
2. Dividends
Dividends count toward the 3.8% NIIT. This applies to both qualified and ordinary dividends.
If you want to minimize the impact of NIIT, you can rebalance the portfolio to emphasize growth stocks over dividend-paying stocks. That said, make sure your overall asset allocation and risk tolerance are not compromised just to save on taxes.
Where possible, holding higher-dividend investments inside tax-advantaged accounts can also reduce exposure.
3. Capital gains timing & tax-loss harvesting
Capital gains increase net investment income, which can trigger or increase NIIT.
Some planning ideas:
4. Lower your adjusted gross income
If you stay below the income threshold, you don’t pay the net investment income tax at all.
Make sure you’re taking advantage of accounts that lower your income, such as:
This helps reduce your regular income tax and the potential NIIT.
5. Installment sales
If you can, spreading the gains from the sale of an investment property over multiple years may reduce the impact on your taxable income and limit how much of the gain is subject to the NIIT in any one year.
6. 1031 exchange
If you own investment real estate, a 1031 like-kind exchange can defer capital gains and reduce the immediate impact of the NIIT.
This doesn’t eliminate the tax forever, but it can significantly improve cash flow and tax efficiency.
Final thoughts
The net investment income tax often gets overlooked, but for higher earners, it can add thousands of dollars to the tax bill without you even knowing.
A few small planning decisions, like asset location, income timing, and account contributions, can make a difference over time.
I hope you enjoyed this one. Looking forward to your comments!
Bogdan Sheremeta is a licensed CPA based in Illinois with experience at Deloitte and a Fortune 200 multinational.
We did repairs on our rental properties that we could have put off a couple of years so that we could both avoid the NIIT and take partial advantage of the the new senior deduction that doesn’t completely phase out until the income for a couple tops $250k.
I got surprised by that one year when I did a large Roth conversion. I normally do not have enough income to worry about it and it was not on my radar. Another way for the masked man to get you.
From google:
The 3.8% Net Investment Income Tax (NIIT), introduced in 2013 under the Affordable Care Act (ACA), was primarily designed to fund Medicare expansion and healthcare reforms. It acts as a revenue-raising offset, targeting unearned income—such as capital gains, dividends, and interest—for high-income individuals, estates, and trusts.
Key Aspects of the Original Purpose:
Often called the “Medicare surtax,” this 3.8% tax is not adjusted for inflation, meaning more taxpayers may become subject to it over time
Another part of the Medicare surtax is the 0.9% additional Medicare tax assessed on employment income over the same limits as the NIIT.
Seems inevitable to get hit w/NIIT (& IRMAA) taxes/surcharges. I had $160k cap gain hit in growth MF distribution in Dec. so that alone means 3.8% x $160k= $6k in taxes. Or more. $72k pension, $95k roth conversion, + 401k $84k & i’m well over $250k joint MFJ MAGI. Medicare starts this yr, so IRMAA is inevitable. True, I’m blessed by great investments I made & saved for, but I’m paying more in taxes since retirement trying to convert $1M trad IRAs to Roths, pension, large cap gains, etc. I don’t know what else to do to reduce taxes (I moved to NC for flat 4% state income tax rate from 8% Virginia, too). Any other suggestions?
Get rid of that mutual fund distributing capital gains.
This is excellent. Thank you.
There are ways to decrease this tax. When you are filling out your 8960, read the instructions for lines 9a, 9b, and 9c very carefully.
These articles with tips that can help higher earners are very interesting and helpful – thank you!
Thanks for putting the spotlight on this investments tax. One other thing to note is that the income thresholds for this tax are not inflation adjusted. Therefore, this tax will affect more and more people over time and with higher amounts.
Yup. I remember when it first came out. We were not close to making $250k. But we’ve been hit with this tax for about the last 10 years. It sucks.
Be careful using traditional 401(k) just to avoid NIIT instead of contributing to Roth 401(k). If the 401(k) performs well, you might find your balance is so large that even with reasonable Roth conversions you’re setting yourself up for IRMAA and higher tax brackets (and NIIT!) when you take RMDs. (Nice problem to have.) You might get the traditional-Roth tradeoff right if you have a crystal ball that shows you future tax law and your future cash needs, and your doctoral thesis was in linear programming.
Bogdan, you make a great point that concentrating solely on lowering taxes can sometimes be detrimental to after tax return or asset allocation/risk tolerance. The entire picture has to be considered, which is one reason why an investment in a good CPA may be cheaper, in the long run, than DIY tax preparation.
Thanks Bogdan! Given tax season is upon us, where can I find the amount of NIIT due when I file my taxes?
Good explanation and planning suggestions.
Good information Bogdan and good suggestions.
I do find it interesting that strategies to avoid or minimize taxes are well accepted for most Americans and widely used, but similar strategies used by the superb wealthy to accomplish the same goal are loudly criticized as cheating.
If it’s not illegal then it seems to me a tax strategy is fair at all income and wealth levels.
Your proposition that something is fair just because it is legal needs to be subjected to a bit of critical analysis, in view of the economic disparities among the US population.
I see no problem with billionaires if that is your reference nor do they cause inequality.
In fact, financial inequality is not a problem. The problems come from using wealth to wield influence and that takes two to play.
I maintain that most of the wealthiest among us have made significant and ongoing contributions to a better society for everyone. If they never did what they did we would all be worse off from Sam Walton to Musk, maybe even Taylor Swift😎
They make their wealth in the stock market and other investments.
“Financial inequality is not a problem.” Surely you don’t really believe that, do you? I’d be troubled if HD readers assume that financial inequality is not a major issue in US society today. Sure, in general, billionaires don’t “cause” inequality. The more pervasive problem plays out at much lower millionaire levels. I agree that the influence wielded by the ultra-rich is a problem (this is where billionaires “can” cause inequality). But there is also a problem with the current “rules of the game” that furnish such individuals abundant protections to keep their tremendous assets shielded from taxation in ways unavailable to us mere mortals because of the scale involved. For example, members of this class can earn a stated “income” of, say, 50k or 100k, or in the case of Mark Zuckerberg, $1.00, but possess other assets that might garner 100m or more annually (on paper), with none of the latter subject to taxation, though that same paper wealth can be used as collateral to borrow, say, 50m or so, to make another 100m or so, and when all is said and done, they end up owing Uncle Sam nothing because of the “rules” they are able to take advantage of. Billionaires can live lives of luxury not even fathomable to the rest of us, and then at the end pass along their billions to their heirs, where it will be stepped-up, avoiding any diversion to the common coffers. That’s profound inequality in action that has generational consequences. Moreover, billionaires are hardly the only ones who have made our common lives better, or even the most important. Countless thousands have made contributions to our common good as great or greater than Sam Walton (not quite sure what contribution you’re thinking of there) or Elon Musk. I find it odd that you seem to be in thrall to billionaires and are concerned that they receive their proper fealty from the rest of us, even as you claim that “financial inequality is not a problem.”
At one time we were told that millionaires were the problem. Today with more than 24 million millionaires in the U.S. and adding 1,000 per day, politicians who are multi-millionares now tell us it is the billionaires who are the problem. BTW, the U.S. has more millionaires than any other country. Importing poor certainly hasn’t helped to improve the wealth disparity problem. It took me decades of hard work, the avoidance of stupidity and good luck to get where I am today. And I did it through multiple recessions and stock market corrections. I suspect there are many who expect to get there quickly, despite their mistakes and with little work. They are angry.
Inflation, too, should get credit for making more millionaires.
The problem is the people at the bottom 20% and how to make things better for them, raise them up. The problem is poverty, poor education.
The problem is not those who have achieved outsized success.
Yes, the bottom 20% need the help you specify. How are they helped by giving billions of tax advantages to the super wealthy? Are those who have achieved outsized success unable to get by on 100, 500, or 1000 million? These are the numbers in play for the ultra wealthy. Soon you have an oligarchy, with no connection for the poor fellow who only has 50 million and a small luxury yacht.
I didn’t make that up, that’s is the consensus of economists. What is the exact problem with one person earning $45,000 and someone else earning $450,000 or higher? Does the higher paid block the opportunity for lower paid in any way?
You didn’t make what up? The reference is unclear. I am not talking about pay or earnings, but the unearned income of billionaires.
I suppose you don’t see anything wrong with billionaires funding politicians who repay them by enacting tax breaks that favor the Uber wealthy.
Billionaires, corporations, unions PACS – does it matter? The problem is the politicians.
Mutual fund companies (e.g., Vanguard, Fidelity), Brokerage firms, Insurance companies (annuities + Roth conversions later on) All lobbied hard for Roth Accounts that benefit a lot of people.
Dick, I don’t begrudge anyone taking advantage of legal means to reduce taxes. I have issues with the fact that some of those ‘means’ exist in the first place. Heck, I don’t think it’s fair (to younger folks) that I get to deduct $12k from my income this year just ‘cause I’m old, but I’m still gonna do it. So what right do I have to criticize billionaires that do the same?
Still, it just doesn’t seem logical to provide all these tax breaks when the national debt is approaching $40,000,000,000,000.
I sure agree with that. There should not be any tax reductions.
I completely concur with your statements!
Me too!
Thanks Bogdan. For those who have an income in this range, it seems like NIIT is an easy number to manage income to. IRMAA thresholds are hard because of the two year look back and their cliff-like nature. The NIIT threshold is very clear, and if one tries to manage their income to it and goes over, the extra tax is gradual. Plus, in managing to NIIT, one has already accepted that they’ve gone over the first IRMAA tier threshold of around $220k, but they’re fortunately a long way from the next one of around $275k. So in managing to NIIT one basically has decided to not worry about IRMAA. Of course since NIIT doesn’t get inflation adjusted this won’t last.