The Net Investment Income Tax (NIIT) almost always tends to catch high earners by surprise– sometimes, it feels like new tax rules and stipulations (like the AMT) are flying out of the woodwork at every turn. 

Call it what you want, the NIIT, an additional 3.8% tax on certain types of investment income for individuals with high modified adjusted gross incomes (MAGIs), is inconvenient. Still, proper planning can mitigate it or even completely avoid it.

Our NIIT guide dives into the basics, its impact on your overall tax liability, who it most likely affects, and most importantly, how you can reduce its impact through strategic financial planning.

What is the Net Investment Income Tax (NIIT)?

If the NIIT feels like something new, it’s because it somewhat is.

The NIIT, introduced by the Affordable Care Act in 2013, aims to help fund Medicare. It applies an additional 3.8% tax on investment income for individuals and households exceeding specific income thresholds. 

Investment income includes interest, dividends, capital gains, rental and royalty income, and non-qualified annuities– more on this below.

In 2024, these thresholds are:

• $200,000 for single filers
• $250,000 for married couples filing jointly
• $125,000 for married couples filing separately

Income Subject to and Excluded from NIIT

Let’s dive into the details of income the NIIT targets. 

Interest income includes earnings from savings accounts, CDs, and bonds.

Dividends from stocks, including both qualified and non-qualified dividends.

Capital gains, such as your profits from selling stocks, bonds, and real estate that isn’t used as your primary residence. 

Rental and royalty income, such as earnings from rental properties and royalties from intellectual properties.

Distributions from annuities that don't qualify for tax deferral.

The NIIT targets casts a pretty broad net with its definition of investment income and doesn’t target your wages, benefits, or retirement plan distributions.
Specifically, the NIIT excludes wages, unemployment compensation, Social Security benefits, alimony, tax-exempt interest, self-employment income, and distributions from qualified retirement plans (401(k)s, IRAs, etc.).

Who is Affected by NIIT?

We know the NIIT targets high-income earners with substantial investment income, but who exactly fits our definition?

You’re affected if your MAGI exceeds the mentioned thresholds and you have net investment income. 

Your MAGI is typically used to determine eligibility for certain tax benefits and credits.

Simply put, your MAGi is your total income (wages, investment income, and other sources) with specific deductions added back in.

The adjustments that need to be added back to AGI to calculate MAGI can vary depending on the specific tax provision. Still, they include things like tax-exempt interest (from municipal bonds), IRA contributions, passive losses or passive income, and more. 

You can refer to the IRS instructions for Form 8960 for detailed information on calculating MAGI. 

The NIIT calculation applies the 3.8% rate to the lesser of your net investment income or the amount your MAGI exceeds the threshold.

For example, if Bob is a single filer with a MAGI of $250,000 and $60,000 in net investment income, the NIIT applies to $50,000 (the amount his MAGI exceeds the $200,000 threshold), resulting in a $1,900 tax.

Alternatively, if, instead, Bob had a MAGI of $250,000 and only $30,000 in net investment income, the NIIT would apply to the lesser $30,000 figure, resulting in a $1,140 tax (3.8% of $30,000).

Calculating your NIIT

Before you whip out the Google Sheets and calculators, the NIIT is typically calculated by your tax planning software or financial planner. However, it’s still helpful to understand how the proverbial hot dog is made by walking through the process yourself.

1. Determine Your MAGI by adding your adjusted gross income (AGI) and any excluded foreign income.
2. Identify your net investment income by summing up all your income and subtracting related expenses (e.g., investment interest expenses and advisory fees).
3. Compare and apply the tax to the lesser amount. 

For example, 

• AGI: $240,000
• Excluded foreign income: $10,000
• MAGI: $250,000
• Net investment income: $70,000
• Excess over threshold: $50,000 (MAGI - $200,000 threshold for single filers)
• NIIT: 3.8% of $50,000 = $1,900

How to Minimize Your NIIT Impact

The most common way to minimize NIIT impact is through tax-advantaged accounts like 401(k)s, IRAs, and HSAs. 

Contribute the maximum allowed to your applicable retirement accounts, and these contributions will reduce your taxable income and, subsequently, your MAGI.

HSA contributions are tax-deductible, lowering your MAGI. Plus, HSAs grow tax-free if used for medical expenses– just one of the HSA triple tax advantages.

Rental property deductions are a popular way to offset rental income with related expenses like mortgage interest, property taxes, and depreciation. In that same vein, 1031 exchanges allow you to defer capital gains taxes on investment property by reinvesting proceeds in similar properties.

Tax loss harvesting– selling underperforming investments to realize losses that can offset capital gains– also reduces your net investment income.

A fourth of our handpicked strategies include charitable contributions to Donor-Advised Funds (DAFs), allowing you to claim a charitable deduction and reduce your MAGI. You can also donate appreciated stocks or mutual funds to avoid paying capital gains tax and get a charitable deduction.

And, if possible, you can defer your income to a future year when your MAGI might be lower—typically something easier to orchestrate in Q4 and through a self-employed avenue. 

Reducing NIIT in Action

Let's dive into a few examples to see how minimizing your NIIT impact works in practice.

#1: Maximizing Retirement Contributions

A high-income earner, John maximizes his contributions to his 401(k) and HSA. Let's look at the numbers:

• Annual Salary: $250,000
• Potential Net Investment Income: $30,000
• 401(k) Contribution Limit (2024): $23,000 
• HSA Contribution Limit (2024): $4,150
• Total Contributions: $27,150 (assuming he is under 50 and not making catch-up contributions)

By contributing the maximum to his 401(k) and HSA, John reduces his taxable income by $27,150:

• MAGI Before Contributions: $250,000
• MAGI After Contributions: $250,000 - $27,150 = $222,850

Although this reduction in MAGI doesn't bring him below the $200,000 NIIT threshold for single filers, it does reduce the amount subject to the NIIT.

• Excess Over Threshold: $222,850 - $200,000 = $22,850
• NIIT Applies to the Lesser of $22,850 or $30,000 = $22,850
• NIIT Liability: 3.8% of $22,850 = $868.30

If he were taxed the NIIT on his entire $250,000 MAGI, he’d owe $1,900. 

Since he maxed out his retirement and HSA contributions, John saved $1,032 on his NIIT. 

#2: Tax-Loss Harvesting

Emily's MAGI is $225,000. She reviews her portfolio and identifies stocks with unrealized losses. She decides to sell these stocks to offset her capital gains.

• MAGI: $225,000
• Capital Gains: $50,000
• Unrealized Losses: $20,000
• NIIT Threshold for Single Filers: $200,000

By selling the losing investments, Emily can offset $20,000 of her capital gains:

• Net Capital Gains: $50,000 - $20,000 = $30,000
• Net Investment Income After Loss Harvesting: $30,000

Emily's MAGI exceeds the NIIT threshold by $25,000 ($225,000 - $200,000 = $25,000).

The NIIT applies to the lesser of her net investment income ($30,000) or the excess over the threshold ($25,000):

NIIT Liability Before Tax Loss Harvesting: $1,900

NIIT Liability After Tax Loss Harvesting: 3.8% of $25,000 = $950

By tax-loss harvesting, Emily reduces her net investment income and saves $950 ($1,900- $950) in NIIT.

#3: Real Estate Investments

Mike (MAGI: $240,000) owns several rental properties, diligently tracking all related expenses and taking advantage of depreciation deductions. 

• MAGI: $240,000
• Rental Income: $100,000
• Expenses (mortgage interest, property taxes, repairs): $50,000
• Depreciation Deduction: $40,000
• Net Rental Income: $100,000 - $50,000 - $40,000 = $10,000

Since Mike's MAGI is $240,000, which is above the $200,000 threshold for single filers, he’ll be subject to the NIIT for $40,000. 

The NIIT applies to the lesser of his net investment income ($10,000) or the excess over the threshold ($40,000).

• NIIT Liability: 3.8% of $30,000 = $380

Now, a seasoned rental property owner, Mike was likely well aware of the tax advantages of using qualified expenses and depreciation. However, assuming he didn’t claim any expenses or depreciation, Mike’s $100,000 rental income would be the higher of the two (MAGI), so his NIIT would be taxed on the excess $40,000 ($1,520) MAGI. 

NIIT FAQs

Every situation is different, so it’s critical to get a complete view of your financial picture from a financial planner with explicit experience working with high-earners. 

If my MAGI doesn't meet the threshold but my investment income is much higher, will the NIIT impact me?

No, the NIIT only applies if your MAGI exceeds the applicable threshold ($200,000 for single filers, $250,000 for married filing jointly). Even if you have substantial investment income, if your MAGI is below these thresholds, the NIIT doesn’t apply.

How does the NIIT interact with self-employment income?

Self-employment income itself isn’t subject to the NIIT. 

However, if your overall MAGI, which includes self-employment income and net investment income, exceeds the threshold, your investment income will be subject to the NIIT. 

What if I have no investment income but a very high MAGI?

If you have no net investment income, the NIIT does not apply to you, regardless of how high your MAGI is. 

The NIIT specifically targets net investment income, and without any, you won't be subject to this tax. 

However, having a high MAGI could still result in other tax implications, such as being pushed into a higher income tax bracket or facing limitations on certain deductions and credits. 

How can I avoid the NIIT by deferring income?

Most commonly, by deferring bonuses, capital gains, or other forms of income to a future tax year, you can keep your current year’s MAGI below the NIIT threshold. 

However, this requires careful planning to ensure that deferring income does not push you over the threshold in subsequent years.

Making Cents of NIIT and Additional Resources

The Net Investment Income Tax can significantly impact high-income earners who also dabble in various forms of investing, but with strategic planning, you can shield yourself from most of it and possibly even completely avoid it. 

It’s worth noting that the NIIT isn’t the only tax concern once income levels are higher. For example, the Alternative Minimum Tax (AMT) can further complicate things, and it often interplays with the NIIT. Being subject to the AMT does not exempt you from the NIIT, and you could potentially owe both taxes if you meet the criteria for each.

However, some savvy tax planning can get you ahead of the ball and help you keep more of what you earned. 

Remember, individual financial situations can be very nuanced, taking into account personal goals, retirement date targets, family, savings, and earning schedules. Tailored financial advice from a financial planner can help connect the dots. 

Further Recommended Reading and IRS Resources

1. Instructions and details on calculating the NIIT: IRS Form 8960 - Net Investment Income Tax - Individuals, Estates, and Trusts
2. Detailed explanations of various types of income, including investment income. IRS Publication 525 - Taxable and Nontaxable Income
3. Details on various deductible business expenses, which can impact your overall taxable income. IRS Publication 535 - Business Expenses