Advanced TopicsIntermediate5 min read

The 3.8% net investment income tax, explained

A surtax that quietly raises the real rate on your dividends, interest, and capital gains once your income crosses a threshold — who owes it and how to soften it.

Many higher earners are surprised to learn their true tax rate on investment income is a few points higher than the headline capital gains or dividend rate. The culprit is the net investment income tax (NIIT): a 3.8% surtax that stacks on top of your regular tax once your income passes a set threshold. It has been around since 2013, it is not indexed for inflation, and it catches more people every year.

Who owes it

The NIIT applies when your modified adjusted gross income (MAGI) exceeds a fixed threshold — commonly cited as $200,000 for single filers and $250,000 for married filing jointly (check the current figures). You pay 3.8% on the LESSER of your net investment income or the amount by which your MAGI exceeds the threshold. So just crossing the line does not tax all your income — only the overlap.

The 'lesser of' rule in action

A married couple has MAGI of $270,000, which is $20,000 over the $250,000 threshold, and $50,000 of net investment income. They owe 3.8% on the LESSER of those — $20,000 — for about $760. If instead they had $300,000 MAGI and $50,000 of investment income, they would owe 3.8% on the full $50,000, or $1,900.

What counts as net investment income

Subject to NIIT	Not subject to NIIT
Taxable interest and dividends	Wages and self-employment income
Capital gains (including home-sale gains above the exclusion)	Municipal bond interest (tax-exempt)
Rental and royalty income (if passive)	Distributions from IRAs and 401(k)s
Passive business income	Income from an active trade or business

Income the NIIT touches — and skips

Ways to reduce it

Manage MAGI: since the tax hinges on crossing a threshold, tactics that lower MAGI — retirement contributions, tax-loss harvesting, timing capital gains — can shrink or avoid it.
Favor municipal bonds in taxable accounts: their interest is exempt from the NIIT as well as regular income tax.
Hold income-producing investments in tax-advantaged accounts, where distributions do not count as net investment income.
Spread large capital gains across tax years to avoid a single year of high MAGI.

It sneaks up during one-time events

Selling a business, a rental property, or a highly appreciated home can spike your MAGI and your investment income in the same year — a double hit for the NIIT. Because the thresholds are not inflation-indexed, more households cross them over time. Plan large sales with a CPA; this is educational information only.

The bottom line

The 3.8% NIIT raises the real tax rate on investment income for higher earners, applying to the lesser of your net investment income or your MAGI above the threshold. It skips wages, muni interest, and retirement-account distributions. Because it is threshold-based and not indexed, MAGI management — harvesting losses, timing gains, using tax-advantaged accounts and municipal bonds — is the main lever. Watch out especially in the year of a big one-time sale.

Check your understanding

1 of 3

A married couple has MAGI of $260,000 (threshold $250,000) and $40,000 of net investment income. Roughly how much NIIT do they owe?

Not quite — try again.

The Worth letter

Get smarter about money every week

One email, no spam — practical guides and Worth updates. Unsubscribe anytime.

Put this into practice

Worth tracks your accounts, budgets, and goals — so the concepts in this article aren't just theory.

Start free trial