The 3.8% Net Investment Income Tax is a surcharge on investment income for higher-income taxpayers. Enacted as part of the Affordable Care Act (P.L. 111-148, 2010) and effective since 2013, it has been in place for over a decade but remains one of the most frequently overlooked taxes in planning conversations. It applies on top of regular income tax - it does not replace it.
NIIT = 3.8% × the lesser of: (a) net investment income, or (b) the excess of modified AGI over the applicable threshold.
Translation: You pay 3.8% on whichever is smaller - your total investment income, or the amount by which your income exceeds the threshold. If your MAGI is only slightly above the threshold, you pay 3.8% only on the excess over the threshold, not on all your investment income.
Because the thresholds are not inflation-adjusted, more taxpayers cross them each year. A couple with $250,000 of combined income in 2013 was comfortably at the threshold; with wage growth and appreciation, many more households are now above it than Congress originally intended.
| Income Type | NIIT Applies? | Notes |
|---|---|---|
| Interest income | Yes | Including savings accounts, CDs, bonds, money market funds |
| Dividends | Yes | Qualified and non-qualified dividends |
| Capital gains | Yes | Short and long-term. Crypto gains included. NFT gains included. |
| Rental income (passive) | Yes | Rental income from passive activities. Real estate professionals may be exempt. |
| Annuities (non-qualified) | Yes | The income portion of non-qualified annuity distributions |
| Passive activity income | Yes | Income from businesses in which the taxpayer does not materially participate |
| Wages / salary | No | Employment income is not NII. Subject to regular income tax and FICA only. |
| Self-employment income | No | Active business income is not NII. Subject to SE tax instead. |
| Active business income (S-Corp, partnership) | No | Income from businesses in which taxpayer materially participates. Material participation tests under IRC §469 apply. |
| IRA / 401(k) distributions | No | Distributions from tax-deferred retirement accounts are not NII (but do increase MAGI, potentially pushing other income over the threshold) |
| Social Security benefits | No | Not NII, but taxable portion increases MAGI |
| Tax-exempt interest (municipal bonds) | No | Not included in NII. Does not increase MAGI. |
| Alimony (pre-2019 divorces) | No | Not NII, but increases MAGI |
Rental income is generally subject to NIIT because it is passive income. However, a taxpayer who qualifies as a real estate professional under IRC §469(c)(7) and materially participates in their rental activities can exclude those rental activities from NIIT. Real estate professional status requires: (1) more than half of the taxpayer's personal services during the year are in real property trades or businesses in which the taxpayer materially participates, and (2) the taxpayer performs more than 750 hours of services in those activities. For a taxpayer with a W-2 job, qualifying as a real estate professional is essentially impossible unless the spouse also qualifies and files jointly.
Income from S-Corps and partnerships is not subject to NIIT if the taxpayer materially participates in the activity. Material participation is satisfied if any one of seven tests under Treas. Reg. §1.469-5T is met, the most common being: participation for more than 500 hours during the year, or participation constituting substantially all participation in the activity. A limited partner or passive investor who does not materially participate pays NIIT on their share of pass-through income.
Capital gains from cryptocurrency are net investment income subject to NIIT. A taxpayer who realizes $200,000 of Bitcoin gains and has other income above the threshold pays 3.8% on those gains in addition to the regular capital gains rate. At the top long-term rate, the effective maximum federal rate on crypto gains is 23.8% (20% + 3.8%). Short-term crypto gains face up to 40.8% (37% + 3.8%). This is one of the reasons the long-term holding period matters significantly for high-income crypto investors.