For high-income taxpayers, investment gains can come with an additional tax burden known as the Net Investment Income Tax (NIIT). This 3.8% surtax applies to specific types of unearned income once your income crosses certain thresholds. It can quietly reduce your tax refund—or increase your balance due—if not planned for properly. In this blog, we’ll explain what NIIT is, who it affects, and, most importantly, how to avoid or reduce it legally, so you can keep more of your hard-earned refund.
What Is the Net Investment Income Tax (NIIT)?
The Net Investment Income Tax, established under the Affordable Care Act, is a 3.8% surtax on certain types of investment income for individuals, estates, and trusts whose income exceeds specified thresholds. It is designed to help fund Medicare and applies in addition to regular income or capital gains taxes.
Types of Income Subject to NIIT:
- Interest and dividends
- Capital gains (including from the sale of stocks, mutual funds, real estate)
- Rental income
- Royalty income
- Passive business income (e.g., from partnerships or S corporations where you’re not materially participating)
Active income—like wages, self-employment earnings, or income from an active business—is not subject to NIIT.
Who Has to Pay NIIT?
NIIT kicks in when your modified adjusted gross income (MAGI) exceeds the following thresholds:
- Single or Head of Household: $200,000
- Married Filing Jointly: $250,000
- Married Filing Separately: $125,000
- Trusts and Estates: As little as $14,450 (in 2025) of income may trigger NIIT
These thresholds are not adjusted for inflation and have remained the same since NIIT was implemented. Once you cross them, the 3.8% tax applies to the lesser of:
- Your net investment income, or
- The amount your MAGI exceeds the applicable threshold
How NIIT Affects Your Tax Refund
Since NIIT is an additional tax on top of your regular income and capital gains taxes, it can reduce the refund you’re expecting. Many taxpayers are surprised by this tax because it’s not directly withheld or pre-paid unless specifically planned for. It’s calculated and added to your total tax liability on your return (via Form 8960), which then reduces the refund amount shown on Form 1040.
Strategies to Avoid or Minimize NIIT
Here are proven, legal strategies to avoid or reduce your exposure to the Net Investment Income Tax:
1. Stay Below the NIIT Income Thresholds
If your income is close to the threshold, use deductions and deferral strategies to reduce MAGI:
- Contribute to retirement accounts (IRA, 401(k), SEP, etc.)
- Deduct qualified business expenses or self-employed health insurance
- Take capital losses to offset gains
- Defer income (e.g., delaying bonuses or asset sales)
2. Offset Investment Gains with Capital Losses
Tax-loss harvesting is a technique where you sell losing investments to offset gains in the same year. It reduces your net investment income and may lower or eliminate NIIT exposure.
- You can deduct up to $3,000 of net capital losses against ordinary income
- Excess losses can be carried forward to future years
3. Invest in Tax-Exempt Bonds
Interest from municipal bonds is not considered investment income for NIIT purposes. Shifting some of your fixed-income investments to tax-exempt bonds can help reduce your exposure to NIIT.
4. Use Roth Accounts Instead of Traditional Accounts
Withdrawals from Roth IRAs and Roth 401(k)s are not included in MAGI for NIIT. If you expect to cross the NIIT threshold in retirement, consider converting some of your traditional retirement accounts to Roth now to avoid higher future NIIT liability.
5. Consider Real Estate Professional Status
If you earn rental income but actively manage your properties and meet the IRS criteria as a real estate professional, your rental income may be considered non-passive and therefore exempt from NIIT.
To qualify, you must:
- Spend more than 750 hours per year materially participating in real estate activities
- Spend more than half your total working hours on real estate
6. Utilize Installment Sales
Instead of recognizing a large gain in a single year (which could trigger NIIT), structure large asset sales using an installment method. This spreads the gain—and thus investment income—over several years, possibly keeping your MAGI under the NIIT thresholds annually.
7. Make Qualified Charitable Distributions (QCDs)
If you’re over age 70½, you can donate up to $100,000 directly from your IRA to charity using a QCD. These distributions are excluded from income, thereby reducing your MAGI and potentially eliminating NIIT liability.
Filing Requirements: Form 8960
If you’re subject to NIIT, you must file Form 8960 – Net Investment Income Tax with your tax return. This form calculates the additional 3.8% tax based on your investment income and MAGI.
How to Complete and Attach Form 8960:
- List all sources of net investment income: dividends, capital gains, rental income, etc.
- Report deductions attributable to that income (investment advisory fees, margin interest, etc.)
- Calculate the applicable NIIT based on your MAGI and income thresholds
- Attach Form 8960 behind your Form 1040 and include the NIIT amount on Schedule 2, Line 17
Failing to include Form 8960 when required can result in penalties or an IRS notice adjusting your return.
What Counts Toward MAGI for NIIT?
MAGI for NIIT purposes is your Adjusted Gross Income (AGI) from Form 1040 plus any foreign earned income exclusions. This includes:
- Wages
- Self-employment income
- Interest, dividends, and capital gains
- Taxable Social Security benefits
- IRA and pension distributions (unless Roth)
Reducing your MAGI is key to avoiding the NIIT, even if you have substantial investment income.
Common Misconceptions About NIIT
- NIIT doesn’t apply to all high-income taxpayers: Only those with both high MAGI and net investment income are affected.
- NIIT applies only to unearned income: Your wages and self-employment income aren’t subject to NIIT.
- NIIT is separate from the Medicare tax on wages: The 0.9% Additional Medicare Tax on wages is different from the 3.8% NIIT on investments.
NIIT and Estates or Trusts
Estates and trusts can also be subject to NIIT if they have investment income and reach a much lower income threshold (around $14,450 in 2025). Trustees should consider:
- Distributing income to beneficiaries (distributable net income)
- Utilizing expenses to offset investment income
- Tax-efficient asset placement strategies
Conclusion: Proactive Planning Keeps Your Refund Intact
The Net Investment Income Tax is a stealthy surtax that can reduce your refund significantly if not addressed. The best way to avoid or reduce NIIT is to plan ahead by managing both your MAGI and the amount of net investment income you generate in a given year. Utilizing tools like tax-loss harvesting, retirement account contributions, Roth conversions, and installment sales can make a measurable difference in your tax outcome.
If your income fluctuates or you expect a large capital gain in a particular year, work with a qualified tax advisor who understands NIIT and can help you implement strategies tailored to your financial situation. By staying informed and planning wisely, you can minimize exposure to the 3.8% NIIT and maximize your refund in 2025 and beyond.
