Net Investment Income Tax

The net investment income tax, NIIT, is a 3.8% surtax that took effect in 2013 under the Affordable Care Act, computed on Form 8960. It applies to the lesser of net investment income or modified adjusted gross income above the threshold: $200,000 for single filers and heads of household, $250,000 for married filing jointly, $125,000 for married filing separately. Net investment income means interest, dividends, capital gains, rental and royalty income, and passive business income. Wages, self-employment income, distributions from a 401(k) or IRA, and municipal bond interest are all outside the tax.

The thresholds are fixed by statute and not indexed for inflation, which is the provision's slow trap: salaries rise, the lines do not, and the crossing population widens every year. The surtax stacks on the regular rates rather than replacing them, so a long-term capital gain nominally taxed at 15% is 18.8% above the threshold, and the top 20% rate becomes 23.8%. A separate 0.9% additional Medicare tax applies to wages above the same thresholds, which is a different tax that shares the lines. State income tax stacks on top of all of it with no NIIT involvement.

The arithmetic runs on Form 8960: net investment income is totaled, MAGI minus the threshold is computed, and the tax is 3.8% of whichever figure is smaller. A married couple with $320,000 of MAGI and $60,000 of dividends and capital gains has a $70,000 excess, so the tax is 3.8% of the lesser $60,000, or $2,280. The lesser-of structure caps the bill at the excess, which is the feature that softens the cliff near the line. A taxpayer $5,000 over the line with $60,000 of investment income pays $190, not $2,280.

MAGI is adjusted gross income with the foreign-earned-income exclusion added back, and it counts everything the tax excludes from its base: 401(k) distributions, Roth conversions, and municipal interest all raise the threshold test while never paying the surtax themselves. The base is where the planning lives. Pre-tax 401(k) contributions reduce MAGI and the base together. Rental income from a real estate professional is excluded, while passive rental income is not.

The interaction with the capital gains table is the part most filers miss. The surtax does not appear in the 0/15/20 brackets on the rate cards; it is computed separately and collected with the return, which is why the sticker rate understates the bill above the threshold. The same stacking applies to qualified dividends, which are nominally 15% or 20% and 18.8% or 23.8% above the line. The thresholds have not moved since 2013, and the affected population grows each year as wages rise.

The tax bites hardest at the moments a portfolio is already stressful: a concentrated stock sale, a house with a large gain, a year of outsized fund distributions. Above the threshold the effective rate on long-term gains is 18.8% at the 15% bracket and 23.8% at the top, and the surtax line arrives with the return rather than through withholding. The gap between the sticker rate and the real one is 3.8 points, which is the size of the surprise.

I watched a colleague named Brent (yes, that Brent) sell a concentrated stock position for a $180,000 gain and budget the 15% he had memorized. The NIIT took 3.8% of the gain on top, $6,840, and the state took its share besides. The rate card he read was not wrong; it was just not the whole card.

The highest-leverage thing most Americans can do is know the threshold before a large sale and spread the gain across tax years when that keeps MAGI under the line. Estimate the bill with the NIIT calculator and the full bracket with the marginal tax rate calculator. The surtax is not avoidable on income that remains above the line; it is avoidable on income that never gets there.