What is Net Investment Tax (NIIT) and who pays it?

If you don’t know what Net Investment Tax (NIIT) is, you are not alone. This relatively new tax was introduced just over a decade ago, but the number of taxpayers subject to this tax has increased.

For example, Show data that 3.1 million taxpayers were subject to NIIT in the first year. Just eight years later, that number has more than doubled.

So what is NIIT and who has to pay for it?

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Read on to avoid surprises on your next tax bill and find out how you can reduce your net investment income.

What is Net Capital Gains Tax?

Net capital gains tax is a 3.8% tax that you must pay if your modified adjusted gross income (MAGI) exceeds a certain threshold. (More on that later).

Taxpayers who reach this income limit pay tax on the lower of:

Net investment income, OR
The amount exceeds MAGI

The income limits are not linked to inflation, meaning that if inflation increases you would pay a higher tax rate on the same investment value.

Why do I pay net capital gains tax?

Below are the MAGI limits at which you are subject to NIIT:

Filing Married Separately – Income over $125,000
Single or Head of Household – Income over $200,000
Filing Married Jointly – Income Over $250,000

If you have capital gains and your MAGI is below the above amounts, you do not have to pay NIIT.

What counts as net investment income?

Different types of income may be subject to the 3.8% tax, but not all. Below is a list of common examples of capital gains that fall under NIIT:

Additionally, non-qualified annuities (mutual funds, CDs, etc.) may be subject to NIIT.

It is important to consult with a Tax specialist to determine whether an investment you hold is subject to a particular tax.

What is exempt from NIIT?

Some types of income are not subject to NIIT. For example, qualified annuities could be part of a retirement plan and therefore may be subject to different tax rules. (For example: 401(k)s, 403(b)s, 457(b)s, and IRAs).

Other types of income that are generally exempt from NIIT include:

How to avoid net capital gains tax

Here are some types of expenses that can help lower your net investment income. Keep in mind that these will not necessarily help you avoid the tax entirely. Rather, the expenses can help lower your NII and potentially reduce NIIT liability.

Investment interest expenses
Investment advisory fees (or brokerage fees)
Rental and licensing fees related to your rental and licensing income
Tax preparation fees
Fiduciary costs (for estates and trusts)
Local Income and State Taxes

Next, we use an example to show how capital gains can be subject to net capital gains tax.

Example of Net Capital Gains Tax

Note: Keep in mind that this is a simple example. In practice, scenarios can usually be more complex.

Example. A single filer has a salary of $175,000 and a dividend of $80,000 (excluding expenses). This means their net investment income is $80,000. Her MAGI (salary plus dividends) is $255,000.

In this case, MAGI exceeds the single applicant threshold under NIIT ($200,000). This means that the individual filer is subject to the tax.

NIIT takes the lesser of:

The amount the taxpayer exceeds the threshold ($255,000 minus $200,000 = $55,000), OR
Your investment income ($80,000)

Since $55,000 is less than $80,000, NIIT will use $55,000.

Thus, the taxpayer’s NIIT is 3.8% multiplied by $55,000, resulting in a tax of $2,090.

Does NIIT apply to home sales?

In general, NIIT does not apply to items that are normally excluded from your regular item taxable incomewhich involves the sale of a primary residence.

If you plan to sell your primary home, the first $250,000 (single person) or $500,000 (married couple) is generally exempt from capital gains tax. Therefore, it is basically exempt from NIIT. But if the Profit from selling your home is over Exclusion of home ownership from capital gains tax If your MAGI exceeds the threshold, you may have to pay taxes on the excess. Therefore, you can pay NIIT.

Further information can be found at: Capital gains tax on real estate and house sales.

How much is the 3.8% Medicare supplemental tax?

If you are a taxpayer, you are exempt from this Medicare taxesYou may still owe NIIT if you meet the investment and MAGI criteria. While you may be subject to the 0.9% Medicare tax and the 3.8% investment tax, you are not subject to both for the same type of income.

Note: Although both are additional taxes, they are different taxes with different rules. Also, fun fact: The “Medicare tax” does not currently fund Medicare. It is a separate tax that goes to the general fund.

For more information, see Medicare Tax: Five Things Every Worker Needs to Know.

IRS Tax on Net Investment Income: More Information

If you’d like to learn more, the IRS has published a list of NIIT FAQs.

In addition, you will find one Source estimator on the IRS website that can help you estimate your federal income tax withholding, including NIIT.

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