Net Investment Income Tax (NIIT): Who Pays and How to Reduce It

Editor’s Note: This article was originally published in 2022 and has been updated to reflect current Net Investment Income Tax rules, income thresholds, and planning considerations as of 2026.

For high-income taxpayers, investment returns can create an additional tax consideration beyond regular income and capital gains taxes: the Net Investment Income Tax (NIIT).

The NIIT is a 3.8% tax that can apply to certain investment income when a taxpayer’s modified adjusted gross income exceeds specified thresholds. Interest, dividends, capital gains, rental income, and certain passive business income may all be affected, making NIIT an important consideration when coordinating investment and tax planning.

Understanding what income is subject to NIIT, and the planning strategies that may help manage exposure, can help investors make more informed decisions about their portfolios and broader financial plans.

What Is the Net Investment Income Tax (NIIT)?

The Net Investment Income Tax (NIIT) is a 3.8% federal tax on certain types of investment income, including interest, dividends, capital gains, and passive business income. It applies to individuals, estates, and trusts whose income exceeds specific thresholds.

Because NIIT sits at the intersection of investment decisions and tax exposure, coordinating wealth and tax planning can help investors evaluate potential tax consequences within their broader financial strategy.

History of Net Investment Income Tax (NIIT)

The Net Investment Income Tax was enacted as part of the Patient Protection and Affordable Care Act (ACA), as amended by the Health Care and Education Reconciliation Act of 2010. Internal Revenue Code Section 1411 established the tax on certain net investment income of individuals, estates, and trusts.

The NIIT took effect for tax years beginning after December 31, 2012. Since then, it has remained an important tax-planning consideration for higher-income taxpayers with investment and passive income.

What Income Is Subject to NIIT?

Net investment income falls into one of three categories and is generally made up of passive investment income. This includes interest, dividend, annuity, royalty, and rental income, unless those items were derived in the ordinary course of an active trade or business such as income from real estate professionals.

Capital gains from dispositions of property, other than property held in an active trade or business, are also subject to the tax. In addition, any income from a trade or business that is classified as passive activity is subject to tax. This would include income reported to you on a Schedule K-1 from the business activity unless you are an active participant in the business.

Certain alternative investments may also generate income subject to NIIT. Investors should understand the tax implications of hedge fund investments when evaluating their overall investment tax exposure.

Who Pays NIIT Today?

Under the ACA, Internal Revenue Service Code Section 1411 imposes a 3.8 percent tax on a taxpayer’s net investment income. Investment income includes both passive sources like dividends, capital gains, interest, royalties and rents as well as passive business income.

The NIIT will apply to a taxpayer only if their modified adjusted gross income exceeds $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 for unmarried taxpayers and heads of household. The amount subject to the tax is the lesser of a taxpayer’s net investment income or the amount by which modified adjusted gross income exceeds the threshold amount that applies. Thus, a taxpayer will not be subject to the additional tax on net investment income unless their modified adjusted gross income exceeds the respective threshold amount that applies to them.

These income thresholds have not been indexed for inflation, which means more taxpayers may become subject to NIIT over time.

For example, consider a married couple filing jointly with modified adjusted gross income of $300,000 in 2026, including $100,000 of net investment income. Their income exceeds the $250,000 NIIT threshold by $50,000. Because the NIIT applies to the lesser of net investment income or the amount by which modified adjusted gross income exceeds the applicable threshold, the tax would apply to $50,000 rather than the full $100,000 of net investment income. Their Net Investment Income Tax would be $1,900 ($50,000 × 3.8%).

When it comes to business income, the NIIT generally applies to income from a trade or business that is considered a passive activity for the taxpayer, as well as certain businesses involved in trading financial instruments or commodities. Whether income from a partnership or S corporation is subject to NIIT can depend on factors such as the taxpayer’s level of participation in the business. Income from a nonpassive trade or business generally is not included in net investment income, although special rules can apply to certain income and gains involving pass-through entities.

Rental real estate requires additional analysis. Qualifying as a real estate professional does not, by itself, automatically exclude rental income from NIIT. Generally, the taxpayer must also materially participate in the rental activity, and the rental activity must meet applicable trade-or-business requirements for the income to be excluded. The IRS provides additional guidance for real estate professionals in the Instructions for Form 8960, Net Investment Income Tax.

There are several types of income that are exempt from the net investment income tax. Items excluded from income for regular income tax purposes are generally also excluded from net investment income. This would include such items as tax-exempt interest, gains subject to the like-kind exchange rules and the excluded gain from the sale of your principal residence. Additional items of income not included in the definition of net investment income are distributions from qualified retirement plans such as individual retirement accounts and Roth IRAs, and wages and self-employment income.

Have the NIIT Rules Changed?

The core NIIT rules for individual taxpayers remain in place. One important feature of the tax is that the NIIT income thresholds are not indexed for inflation. As incomes increase over time, more taxpayers may become subject to NIIT even though the statutory thresholds themselves have not changed.

Because NIIT exposure depends on both the type of income received and a taxpayer’s modified adjusted gross income, individuals with significant investments, passive business interests, or other income-producing assets should evaluate NIIT as part of their broader tax and financial planning.

How NIIT Can Affect Business Owners

Business owners may encounter NIIT when they receive passive income from partnerships, S corporations, or other business interests. Whether business income is included in net investment income depends on factors such as the nature of the activity and the taxpayer’s participation in the business.

NIIT may also become relevant when a business owner sells an ownership interest. Special rules can apply when determining how much of a gain from the disposition of a partnership interest or S corporation stock is included in net investment income.

Because these rules can be complex, business owners with significant pass-through income, passive investments, or a potential business transaction should evaluate NIIT exposure as part of their broader tax planning.

How to Reduce Net Investment Income Tax (NIIT)

Several tax and investment planning strategies may help taxpayers manage their exposure to NIIT. The appropriate approach depends on the types of investment income received, modified adjusted gross income, business participation, and broader financial goals.

Investments in tax-exempt bonds or securities that are more capital appreciating versus dividend-paying can help reduce the exposure to the tax. Capital loss harvesting has always been a strategy to help reduce capital gains tax on any net capital gains a taxpayer may have but can be even more valuable now as it may also help reduce net investment income tax. Because income from passive activities may be subject to NIIT, taxpayers with business or real estate interests should understand whether they meet the applicable material participation requirements before determining how that income is treated.

Investors with appreciated assets may also consider whether charitable giving strategies fit within their broader tax and financial plan. Donating appreciated assets rather than selling them may offer charitable and tax-planning benefits depending on the taxpayer’s circumstances. For individuals with significant appreciated assets and charitable goals, a charitable remainder trust may also be worth evaluating as part of a broader wealth, estate, and tax strategy.

Taxpayers may also consider strategies for managing modified adjusted gross income over multiple years. The timing of installment sales, retirement contributions, Roth conversions, and other income or deductions can affect both current and future taxable income. For example, an installment sale may spread taxable gain over multiple years rather than recognizing the entire gain in a single year. Because some strategies, such as a Roth conversion, can increase taxable income in the year implemented, their potential impact on NIIT should be evaluated carefully.

These decisions should also be considered within a broader IRA and retirement savings strategy, particularly when managing taxable income before and during retirement.

Coordinate Your Investment and Tax Strategy

NIIT can add another layer of tax exposure for individuals with significant investment, rental, or passive business income. Because liability depends on both net investment income and modified adjusted gross income, decisions involving investments, capital gains, retirement accounts, and other income sources can affect the overall tax picture.

Proactive individual tax planning can help identify potential NIIT exposure and evaluate strategies for managing taxable income.

For individuals with substantial investment portfolios or broader financial-planning needs, talk with an LBMC wealth advisor about coordinating investment decisions with your long-term tax and financial strategy.

Content provided by LBMC tax professional Ben Alexander.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.