By J.R. Robinson, Financial Planner (April 2025)
“Yay- Another article about esoteric tax rules!”… said no one ever. Nonetheless, I have written this one because it keeps popping up as relevant in client tax planning and portfolio management discussions. The Net Investment Income Tax (NIIT) is an additional 3.8% tax that applies to certain investment income for taxpayers whose income exceeds specific thresholds. Introduced in 2013 as part of the Affordable Care Act, this tax can significantly impact investors with substantial income from sources such as interest, dividends, capital gains, rental income, and royalties[1][2][3][4].
What Triggers the NIIT?
You may owe the 3.8% NIIT if your modified adjusted gross income (MAGI) exceeds these thresholds[1][2][4]:
- Single filers: $200,000
- Married filing jointly: $250,000
- Married filing separately: $125,000
The tax applies to the lesser of your net investment income or the amount your MAGI exceeds the threshold[1].
What Counts as Net Investment Income?
Net investment income includes[1][2][3]:
- Interest
- Dividends
- Capital gains
- Rental and royalty income
- Non-qualified annuities
It does not include wages, Social Security benefits, or distributions from qualified retirement plans.
How to Avoid or Reduce the NIIT
There are several strategies to minimize or avoid the NIIT in taxable accounts:
- Keep MAGI Below Thresholds: The most direct way to avoid the NIIT is to keep your MAGI under the applicable threshold. This may involve deferring income, managing capital gains, or timing asset sales[5].
- Increase Investment Expenses: Since the tax is based on net (not gross) investment income, deductible investment expenses-such as trading fees, investment interest, and property management costs-can reduce your net investment income[5][3].
- Contribute to Tax-Advantaged Accounts: Contributions to 401(k)s, traditional IRAs, HSAs, and similar accounts can lower your taxable income and potentially keep you below the NIIT thresholds[5].
- Roth Conversions with Caution: While Roth conversions can provide long-term tax benefits, they increase your MAGI in the year of conversion and may trigger the NIIT, so plan conversions carefully[5].
- Prepay Deductible Expenses: Prepaying state and local taxes or investment interest related to your investments can help reduce net investment income for the year[5].
Conclusion
The Net Investment Income Tax can add a significant tax burden for higher-income investors. By understanding what triggers the NIIT and using strategies to manage your MAGI and investment income, you can potentially avoid or reduce this tax in your taxable accounts[1][5][3]. As a practical matter, it is most often triggered in my practice by Roth Conversions. To manage this potential issue, I encourage all FPH clients to consult with their tax advisors before processing a Roth Conversion (or any other transaction that may have significant tax consequences).
John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the new personal finance website NestEggPF.com.
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- https://www.schwab.com/taxes/net-investment-income-taxes
- https://www.irs.gov/individuals/net-investment-income-tax
- https://www.investopedia.com/terms/n/netinvestmentincome.asp
- https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax
- https://tanphan.com/blog/avoiding-the-38-net-investment-income-tax
