Net investment income tax (NIIT)

Explanation

The net investment income tax applies to individuals, estates and trusts. For individuals, the thresholds based on modified adjusted gross income (MAGI) are:

• $200,000 single or head of household
• $250,000 married filing jointly
• $125,000 married filing separately

These amounts are set in law and are not adjusted for inflation, so they bite harder each year.

Net investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuity income, and passive business income. It does not include wages, self-employment income, Social Security benefits, tax-exempt municipal bond interest, or distributions from retirement accounts such as 401(k)s and IRAs. However, retirement distributions and Roth conversions do raise your MAGI, which can push more of your investment income into the NIIT zone.

The tax is 3.8% of the smaller of your net investment income or the amount by which your MAGI exceeds the threshold. Combined with the 20% top capital gains rate, the maximum federal rate on long-term gains is 23.8%.

In scenarios, the app checks each year’s projected MAGI against the threshold (held fixed in nominal dollars) and adds NIIT on the applicable investment income, for example in a year with a large taxable sale.

Example

A single filer has $180,000 of wages and $80,000 of long-term gains and dividends, for MAGI of $260,000.

• Excess over threshold: $260,000 − $200,000 = $60,000
• Net investment income: $80,000
• NIIT applies to the smaller amount, $60,000
• NIIT = $60,000 × 3.8% = $2,280

If the same person had only $30,000 of investment income and MAGI of $210,000, the excess would be $10,000 and NIIT would be $10,000 × 3.8% = $380.