Net Investment Income Tax (NIIT): Does the 3.8% Surcharge Apply to You?
CORE INSIGHTS
- The Surcharge: NIIT is an extra 3.8% federal tax on passive income (dividends, gains) for taxpayers exceeding specific MAGI thresholds ($200k/$250k).
- Trigger Mechanics: The tax applies to the lesser of your net investment income OR the amount your MAGI exceeds the threshold.
- Planning Lever: Managing MAGI (via 401k contributions) and using tax-advantaged accounts (Roth IRA/HSA) are the primary defenses.
If you are a high-income earner, your investment profits may face a higher hurdle than the standard long-term capital gains tax. The Net Investment Income Tax (NIIT) adds a 3.8% surcharge on certain passive income once your Modified Adjusted Gross Income (MAGI) crosses fixed statutory lines.
Passive Income: Income from assets like stocks, bonds, or rental properties where you are not actively involved in operations.
Imagine you realize a $50,000 long-term capital gain while your income is above the threshold.
• Standard Tax: 20% LTCG rate = $10,000.
• NIIT Add-on: 3.8% Surcharge = $1,900.
• Total Bill: $11,900 (Effective Rate: 23.8%).
Result: The NIIT quietly adds nearly $2,000 to your tax bill on the same gain.
NIIT Thresholds and The Tax Hit
Unlike tax brackets, NIIT thresholds are “cliffs” that are not indexed for inflation. If you cross them, the tax applies.
| Filing Status | MAGI Threshold (Trigger) | Top LTCG Rate w/ NIIT |
|---|---|---|
| Single | $200,000 | 23.8% (20% + 3.8%) |
| Married Filing Jointly | $250,000 | 23.8% (20% + 3.8%) |
| Married Filing Separately | $125,000 | 23.8% (20% + 3.8%) |
*Note: These thresholds have remained fixed since 2013, meaning more taxpayers are hit by NIIT each year due to wage inflation.*
What Counts as Net Investment Income (NII)?
NIIT targets “unearned” income. Knowing what is included—and what is excluded—is key to avoidance.
- Included (Subject to 3.8%): Interest, dividends, capital gains, annuities, royalties, and passive rental income.
- Excluded (Safe): Wages, bonuses, self-employment income, Social Security benefits, and distributions from qualified retirement plans (401k, IRA).
Visualizing the Maximum Tax Impact
*Figure 1: The NIIT effectively creates a new top bracket for capital gains, pushing the federal rate to nearly 24%.*
Strategic Action Steps to Minimize NIIT
Since NIIT is triggered by MAGI, the goal is to keep your reportable income below the threshold or shelter your investment income.
Contributions to a Traditional 401(k) reduce your MAGI dollar-for-dollar. This is the most effective way to stay under the $200k/$250k line.
Realizing capital losses can offset capital gains, directly reducing your “Net Investment Income” figure subject to the tax.
The Bottom Line
- Check Your MAGI: If you are near the $200k/$250k border, defer bonuses or accelerate deductions.
- Asset Location Matters: Keep tax-inefficient assets out of taxable brokerage accounts.
- Don’t Panic: NIIT only applies to the excess amount, not your entire income.
Frequently Asked Questions
No. Social Security benefits are exempt from Net Investment Income Tax calculations.
Only if the gain exceeds the Section 121 exclusion ($250k single/$500k married). Any gain above that exclusion is considered capital gain and subject to NIIT.
No. Roth contributions are made with after-tax dollars, so they do not lower your current year’s MAGI. To lower MAGI, you must use Traditional (pre-tax) contributions.