Net Investment Income Tax (NIIT)

The net investment income tax is a flat 3.8% surtax that has applied since January 1, 2013. It is an add-on to regular income tax, not a parallel system like the alternative minimum tax. You figure it on Form 8960 and pay it with your Form 1040.

Two numbers decide it. The first is net investment income: interest, dividends, capital gains, rents, royalties and similar income, minus the expenses allocable to it. The second is how far your modified adjusted gross income exceeds a threshold: $200,000 for single and head of household filers, $250,000 for married couples filing jointly and qualifying surviving spouses, and $125,000 for married people filing separately. The tax is 3.8% of whichever number is smaller, so it never reaches more investment income than you have, or more than your income above the line.

The thresholds are written into the statute and have not changed since 2013, while wages, portfolios and the tax brackets have grown. Estates and trusts owe the tax on undistributed investment income once their AGI passes the start of the top trust bracket, $16,000 for 2026. Nonresident aliens are exempt.

Net investment income starts with gross investment income: taxable interest, ordinary and qualified dividends, payments from nonqualified annuities, rents and royalties, and net gains from selling stocks, bonds, funds and investment real estate, including a second home. Income from a business that is passive to you, or from trading financial instruments or commodities, counts too.

You then subtract deductions properly allocable to that income, such as investment interest expense, rental expenses and, if you itemize, the share of state and local income tax attributable to it. Investment advisory and custodial fees no longer count, because miscellaneous itemized deductions are permanently disallowed.

What stays out matters as much. Wages, self-employment income, Social Security, unemployment compensation and operating income from a business you actively run are not investment income. Neither is interest on municipal bonds, nor gain on a main home that the Section 121 exclusion shelters. Distributions from 401(k), 403(b) and 457(b) plans and from traditional or Roth IRAs are excluded by statute, and a Roth conversion is such a distribution.

The most common NIIT surprise comes from income that is not investment income at all. Wages, pensions, IRA withdrawals, required minimum distributions, Roth conversions and the taxable part of Social Security are all outside net investment income, but each one raises MAGI. If you already have dividends or gains, pushing MAGI over the threshold exposes them to the 3.8%.

That is why the tax often shows up in a retirement year with no unusual investing: a large Roth conversion or a one-time distribution lifts MAGI, and dividends that were never surtaxed suddenly are, as the example below shows. It also appears in a single big year, such as the sale of a rental property, a business interest or a concentrated stock position, where the gain is both investment income and MAGI.

When you price extra income near the threshold, add up to 3.8 cents per dollar on top of income tax. And because the thresholds are frozen, a retiree comfortably under the line today may cross it later as dividends, RMDs and Social Security grow with inflation.

The NIIT is sometimes nicknamed the Medicare surtax, which feeds confusion with the 0.9% Additional Medicare Tax. Both began on January 1, 2013, and both use nearly the same unindexed $200,000, $250,000 and $125,000 thresholds, but they never apply to the same dollar. The Additional Medicare Tax falls on wages and self-employment income above the threshold; the NIIT falls on investment income. A high earner with a large portfolio can owe both, each on its own kind of income.

They are collected differently. Employers must withhold the Additional Medicare Tax once your wages pass $200,000, but nothing withholds the NIIT automatically. You cover it with extra withholding or with estimated tax payments; otherwise you risk an underpayment penalty.

Because the tax is 3.8% of the smaller of two numbers, a strategy helps only if it shrinks the smaller one. If your MAGI is barely over the threshold, lowering any kind of income works, including wages and IRA withdrawals. If your MAGI is far over the line, only cutting net investment income itself reduces the tax. Weigh each move against its effect on income tax, Medicare premiums and the rest of your plan, not against the surtax alone.