Net Investment Income Tax (NIIT): 3.8% Surtax Planning Strategies for 2025

What Is the Net Investment Income Tax (NIIT)?

The Net Investment Income Tax (NIIT) is a 3.8% federal surtax that kicks in when your income crosses specific thresholds. It doesn’t apply to everyone - only to those with significant investment income and high modified adjusted gross income (MAGI). If you’re earning dividends, capital gains, rental income, or interest from taxable accounts, and your MAGI is above $200,000 (single) or $250,000 (married filing jointly), this tax could be affecting you right now.

It’s not a new tax on top of your regular income tax. It’s an extra 3.8% on your investment earnings - but only on the smaller of two numbers: your total net investment income, or how much your MAGI exceeds the threshold. For example, if you’re single and your MAGI is $215,000, and you have $50,000 in net investment income, you only pay NIIT on $15,000 (the amount over $200,000), not the full $50,000. That’s $570 in NIIT, not $1,900.

That’s the key thing most people miss: NIIT isn’t applied to all your investment income. It’s targeted. And because the thresholds haven’t changed since 2013 - no inflation adjustment - more and more people are getting caught in it. In 2013, about 2.9 million returns owed NIIT. By 2025, that number is expected to be over 4 million. If you’re nearing those income levels, this isn’t something you can ignore.

What Counts as Net Investment Income?

Not all income is treated the same under NIIT. The IRS defines net investment income as money you earn from investments - not from working. That includes:

• Interest from bonds and savings accounts
• Dividends from stocks (both qualified and non-qualified)
• Capital gains from selling stocks, real estate, or other assets
• Rental income (unless you qualify as a real estate professional)
• Royalties from patents, music, or mineral rights
• Income from passive business activities - like being a limited partner in a partnership
• Non-qualified annuity payments

But here’s what doesn’t count: wages, Social Security, unemployment benefits, alimony, and most self-employment income. Even more importantly, money inside your 401(k) or IRA isn’t subject to NIIT while it’s growing. Only when you take distributions does it potentially push your MAGI higher - which could trigger the tax.

And don’t forget: tax-exempt municipal bond interest doesn’t count either. That’s one reason why switching from taxable bonds to municipals can be a smart move for high-income investors. You lose a little yield, but you might eliminate the entire 3.8% tax hit.

How NIIT Is Calculated - And Why It’s Tricky

The math behind NIIT is simple, but the implications aren’t. You pay 3.8% on the lesser of:

1. Your net investment income
2. The amount your MAGI exceeds the threshold

Let’s say you’re married filing jointly. Your MAGI is $270,000. Your net investment income is $80,000. The threshold is $250,000. So your excess MAGI is $20,000. You pay NIIT on $20,000 - not $80,000. That’s $760 in NIIT.

Now imagine you get a $10,000 bonus at work. Your MAGI jumps to $280,000. Your excess is now $30,000. But your net investment income is still $80,000. So now you pay NIIT on $30,000 - $1,140. That $10,000 bonus just cost you an extra $380 in NIIT. That’s a 3.8% marginal tax rate on top of your regular income tax. Some people call it the most painful marginal rate they’ve ever seen.

This is why timing matters. A $5,000 capital gain in one year could push you over the threshold. That same gain spread over two years might keep you under. That’s not speculation - it’s a proven strategy used by accountants and financial planners.

How to Reduce or Avoid NIIT - Proven Strategies

NIIT isn’t unavoidable. There are real, legal ways to reduce your exposure - and many people are already using them.

1. Max Out Tax-Advantaged Accounts

Contributing to a 401(k), traditional IRA, or HSA lowers your MAGI. That’s the golden key. Every dollar you defer reduces your MAGI dollar-for-dollar. If you’re close to the threshold, even $5,000 in extra 401(k) contributions could push you below it - and eliminate $190 in NIIT.

2. Tax-Loss Harvesting

If you have capital gains, offset them with losses. You can use up to $3,000 in capital losses each year to reduce your ordinary income - which also lowers your MAGI. That means less NIIT. If you have $10,000 in losses, you can carry forward the unused $7,000 to future years. Do this every year, and you’re systematically reducing your NIIT exposure.

3. Convert to Roth IRA in Low-Income Years

If you’re between jobs, retired early, or have a year with unusually low income, consider converting part of your traditional IRA to a Roth. You’ll pay income tax on the conversion - but you won’t pay NIIT on it, because it’s not investment income. And once it’s in the Roth, future growth is tax-free, and withdrawals don’t count toward MAGI. That means you avoid NIIT later.

4. Donate Appreciated Stock to Charity

Sell stock? You pay capital gains tax. Donate it? You get a deduction for the full fair market value - and you avoid the capital gain entirely. That reduces both your net investment income and your MAGI. Double win.

5. Switch to Tax-Exempt Municipal Bonds

If you’re in a high tax bracket, taxable bonds might not be worth it. A 3.5% yield on a taxable bond might only be worth 2.1% after taxes and NIIT. A 2.8% municipal bond, tax-free at the federal level, gives you the same after-tax return - without triggering NIIT. Many financial advisors now recommend this swap for clients near the threshold.

6. Qualify as a Real Estate Professional

If you rent out property and spend more than 500 hours a year managing it - and more time than any other job - you might be able to treat rental income as active income, not passive. That means it doesn’t count as net investment income. This isn’t easy to prove. You need detailed logs, calendars, emails - but for serious landlords, it’s worth the paperwork.

What You Might Be Getting Wrong

Most people misunderstand NIIT in one of three ways:

• Thinking it applies to all investment income - No, only the portion that pushes you over the threshold.
• Believing retirement accounts are taxed - No, earnings inside IRAs and 401(k)s aren’t subject to NIIT. Only distributions affect MAGI.
• Assuming rental income is always included - Not if you’re materially participating. Many landlords don’t know they can qualify for an exclusion.

And here’s a hidden trap: the 0.9% Additional Medicare Tax. If your income is high enough to trigger NIIT, you’re almost certainly also paying this. Together, that’s a 4.7% surtax on certain income. Most tax software doesn’t flag this clearly - and many people don’t realize they’re paying both.

Real-World Example: How One Client Cut NIIT by $570

A client in Asheville had $248,000 in MAGI and $60,000 in net investment income. He was $2,000 below the $250,000 threshold for married filers. He had $15,000 in taxable bond interest. His advisor suggested shifting that $15,000 into municipal bonds. The yield dropped from 3.8% to 2.9%, but the after-tax return stayed nearly the same - and his MAGI dropped to $233,000. Result? He avoided $570 in NIIT. That’s a 3.8% return on avoiding the tax - better than most bonds.

What’s Changing in 2025?

Nothing major - yet. The thresholds for individuals remain unchanged: $200,000 (single), $250,000 (joint). The estate and trust threshold rose to $15,200 in 2024, and will likely rise slightly again in 2025. But the big story is that Congress hasn’t indexed these thresholds to inflation. That means every year, more people get pulled in - even if their real income hasn’t grown.

By 2028, the Tax Policy Center estimates nearly 4.2% of all tax returns will owe NIIT - up from 2.7% in 2013. That’s a 55% increase in just 15 years. And for people aged 55-64, it’s even higher: nearly 4 in 10 affected filers fall in that group. Baby boomers are hitting retirement with big portfolios - and the tax is catching up.

When to Call a Tax Pro

If your MAGI is within $50,000 of the threshold, you need professional help. The complexity jumps dramatically. Fidelity found that taxpayers with NIIT exposure spend 55% more time on tax prep than those without. TurboTax and H&R Block can handle basic cases - but if you’re juggling capital gains, rental properties, passive income, and retirement distributions, a CPA or enrolled agent can save you thousands.

Don’t wait until April. Start planning in January. NIIT isn’t something you fix with a last-minute deduction. It’s a multi-year puzzle. The best strategies - Roth conversions, tax-loss harvesting, timing sales - need to be planned months in advance.

Final Thought: NIIT Is a Stealth Tax

It doesn’t show up on your paycheck. It’s not labeled on your W-2. But for millions of Americans, it’s a real, unavoidable cost of investing. The government didn’t raise rates - it just widened the net. And because it’s hidden inside the tax code, most people don’t see it coming.

If you’re earning investment income and your income is climbing, NIIT isn’t a problem for someone else. It’s a problem for you - unless you act.