Net Investment Income Tax § 1411: 3.8% Surcharge Guide (2026)

What the NIIT is and where it came from

The Net Investment Income Tax was created by the Health Care and Education Reconciliation Act of 2010 (the companion bill to the ACA) and took effect January 1, 2013. It's codified in IRC § 1411. The rate is 3.8%, applied to the lesser of two amounts:

1. Your net investment income for the year, OR
2. The amount your MAGI exceeds the threshold for your filing status.

The thresholds:

The part most people miss: these thresholds are not indexed for inflation. They haven't changed since 2013. A household that was $30,000 below the line in 2013 may be $50,000 above it today purely from wage inflation — with no increase in real purchasing power. The NIIT is a stealth bracket creep tax.

What counts as net investment income (and what doesn't)

Included under § 1411(c):

• Interest (taxable bonds, savings, CDs)
• Dividends (qualified and non-qualified)
• Capital gains (short-term and long-term, including gains from selling stocks, bonds, mutual funds, ETFs, and real estate)
• Rental and royalty income (net of allowable deductions)
• Non-qualified annuity income
• Income from passive activities (partnerships, S-corps where you don't materially participate)
• Gains from trading in financial instruments or commodities

Excluded:

• Wages and self-employment income from an active trade or business
• Distributions from qualified retirement plans — 401(k), IRA, 403(b), 457(b), pension (IRC § 1411(c)(5))
• Social Security benefits
• Tax-exempt municipal bond interest
• Gain excluded under IRC § 121 (primary residence sale, up to $250K single / $500K MFJ)
• Income from an active trade or business in which you materially participate (the § 469 material participation standard)
• Gain on the sale of an active interest in a partnership or S-corp if you materially participate

The retirement plan exclusion is critical. A $100,000 Traditional IRA distribution adds $100,000 to your MAGI (which can push you further above the threshold), but the distribution itself is not net investment income. It widens the gap on one side of the “lesser of” formula without adding to the other side.

The “lesser of” formula: how the NIIT is actually calculated

This is where most articles on the NIIT stop at the definition and skip the math. The calculation has two moving parts, and misunderstanding which one controls your bill leads to bad planning.

Formula: NIIT = 3.8% × min(net investment income, MAGI − threshold).

Scenario A: investment income is the smaller number

A Chicago single filer. W-2 income: $280,000. Net investment income: $18,000 (dividends + interest). MAGI: $298,000. Threshold: $200,000.

• Excess MAGI: $298,000 − $200,000 = $98,000
• Net investment income: $18,000
• NIIT = 3.8% × $18,000 (the lesser) = $684

Reducing this filer's investment income by $5,000 (e.g., harvesting a $5,000 loss) saves $190 in NIIT. Reducing MAGI by $5,000 (e.g., larger 401(k) deferral) saves $0 in NIIT here — because investment income is already the binding constraint. The MAGI excess is $98,000 either way; it's not the smaller number.

Scenario B: MAGI excess is the smaller number

A Houston couple, MFJ. Combined W-2 income: $240,000. Net investment income: $85,000 (rental income, dividends, $40,000 capital gain from a stock sale). MAGI: $325,000. Threshold: $250,000.

• Excess MAGI: $325,000 − $250,000 = $75,000
• Net investment income: $85,000
• NIIT = 3.8% × $75,000 (the lesser) = $2,850

For this couple, reducing MAGI is the effective lever. A $10,000 increase in 401(k) deferrals drops MAGI to $315,000, reducing the excess to $65,000 and saving $380 in NIIT. Reducing investment income from $85,000 to $75,000 would also work — but only because it would make investment income the new binding constraint at $75,000, tied with the excess.

Key insight: before you plan any NIIT reduction strategy, calculate both sides of the “lesser of” formula. The effective lever depends on which side is smaller.

How NIIT stacks on capital gains rates

The NIIT is purely additive. It does not replace your capital gains rate — it sits on top of it. The 2026 federal LTCG brackets (IRS Rev. Proc. 2025-32):

The effective top federal rate on long-term capital gains is 23.8%, not 20%. Every article, calculator, or advisor who quotes “20% LTCG rate” without mentioning the NIIT understates the bill by 19% for households above the threshold.

Add state taxes and the picture shifts further. California's top rate is 13.3% (no preferential LTCG rate). A California couple above the NIIT threshold selling stock pays 23.8% + 13.3% = 37.1% combined on long-term gains. Washington state added a 7% capital gains tax on gains over $250,000 in 2022, pushing the combined rate to 30.8% for high-gain sales.

Worked example: the full NIIT calculation on Form 8960

A Denver couple, both age 48, married filing jointly. He earns $220,000 as a project manager. She earns $160,000 as a dentist (W-2, not self-employed). Their investment income for 2026:

• Qualified dividends: $12,000
• Interest (bond fund): $6,000
• Long-term capital gain (sold index fund shares): $65,000
• Short-term capital gain (sold individual stock): $8,000
• Investment expenses (margin interest): $2,000

Step 1: Calculate MAGI

Combined W-2: $380,000. Add investment income: $12,000 + $6,000 + $65,000 + $8,000 = $91,000. MAGI: $471,000 (before above-the-line deductions; assume $24,500 each in Traditional 401(k) deferrals = $49,000 in above-the-line reductions, bringing AGI to ~$422,000).

Adjusted MAGI for NIIT purposes: $422,000.

Step 2: Calculate net investment income

Gross investment income: $12,000 + $6,000 + $65,000 + $8,000 = $91,000. Deductible investment expenses (margin interest): $2,000. Net investment income: $89,000.

Step 3: Calculate excess MAGI

$422,000 − $250,000 (MFJ threshold) = $172,000.

Step 4: Apply the “lesser of” test

Lesser of $89,000 (NII) or $172,000 (MAGI excess) = $89,000.

Step 5: Calculate NIIT

$89,000 × 3.8% = $3,382.

This $3,382 is on top of the capital gains tax and ordinary income tax on their investment income. Their total federal tax on the $65,000 LTCG alone: $65,000 × 15% LTCG = $9,750, plus the portion of NIIT attributable to that gain. The NIIT turns a $9,750 expected bill into something closer to $12,000+ when you include the surcharge on all investment income.

Six strategies that reduce NIIT exposure

There is no NIIT deduction or credit. The only way to reduce it is to reduce one or both inputs to the “lesser of” formula: lower your MAGI, lower your net investment income, or both.

1. Maximize above-the-line deductions

Traditional 401(k) deferrals ($24,500 in 2026, plus $8,000 catch-up for age 50+, or $11,250 for ages 60–63 under SECURE 2.0 § 109) reduce AGI dollar-for-dollar. HSA contributions ($4,400 self-only / $8,750 family for 2026) do the same. These don't reduce net investment income directly, but they reduce MAGI — which matters when the MAGI excess is the binding constraint.

2. Tax-loss harvesting

Harvested losses offset realized gains, directly reducing net investment income. A $30,000 harvested loss against a $30,000 realized gain eliminates both from the NII calculation. At 3.8%, that's $1,140 in NIIT savings alone — on top of the LTCG tax savings. The wash-sale rule under IRC § 1091 applies to securities, but not to cryptocurrency as of 2026 IRS guidance.

3. Donate appreciated stock to charity (or a DAF)

Contributing long-term appreciated stock to a Donor-Advised Fund or directly to a charity avoids the capital gain entirely under IRC § 170(e)(1)(B)(i). The gain never appears in net investment income. The deduction also reduces AGI (subject to the 30% of AGI cap for appreciated property). This is a double win: lower NII and lower MAGI.

4. Shift from passive to active participation in business/rental income

Income from a trade or business in which you materially participate under IRC § 469 is excluded from net investment income. If you own rental property and qualify as a real estate professional (750+ hours of material participation), the rental income falls outside NII. The same logic applies to partnership or S-corp income where you actively work in the business. The key test: material participation under the § 469 regulations (seven tests, most commonly the 500-hour test).

5. Use tax-exempt municipal bonds for fixed income

Municipal bond interest is excluded from both MAGI and net investment income. Swapping $100,000 of taxable bond funds yielding 5% ($5,000/yr) for equivalent munis removes $5,000 from both sides of the NIIT formula. At a combined federal + NIIT rate, the after-tax yield comparison often favors munis for households above the NIIT threshold even when the muni coupon is lower.

6. Roth conversions (with NIIT-aware timing)

Roth conversions increase MAGI in the conversion year (the converted amount is taxable income). This can increase NIIT exposure in the short term. But once assets are inside a Roth, all future growth and distributions are excluded from both MAGI and NII. The long-term play: convert in years when your MAGI is already well above the threshold (so the marginal NIIT cost of conversion is zero or small) and permanently remove the asset's future income from the NIIT base.

The timing trap: if your MAGI is just below the $250,000 MFJ threshold, a $50,000 Roth conversion pushes you to $300,000 — exposing your existing $40,000 of investment income to 3.8% NIIT ($1,520 in additional tax). The conversion itself isn't NII, but it widened the MAGI gap. Model this before converting.

Cross-border note: NIIT and the Canada–US Tax Treaty

For Canadian residents earning US-source investment income (dividends, interest, rental income, capital gains from US assets), the NIIT creates a specific problem: the CRA does not recognize the NIIT as a creditable income tax under the Canada–US Tax Treaty.

The treaty's saving clause (Article XXIX-A) allows the US to tax its source income, but the CRA's longstanding position is that the NIIT falls outside the treaty's definition of a covered “income tax” because it's structured as a Medicare-related surcharge, not a direct income tax. This means a Canadian resident who pays NIIT on US dividends cannot claim a foreign tax credit for that 3.8% on their Canadian T1 return.

The practical cost: a GTA-based investor with $50,000 USD in US dividends and capital gains who exceeds the NIIT threshold pays 3.8% ($1,900 USD) to the IRS with no offsetting credit in Canada. That's double taxation on the NIIT portion. If you hold US investments through a Canadian corporation or trust, the analysis gets more complex — a cross-border CPA who specializes in Canada–US individuals is the right call here, and the reason is this specific NIIT non-creditability issue.

NIIT on real estate: the material participation distinction

Rental income is included in NII by default. But the income is excluded if you qualify as a real estate professional under IRC § 469(c)(7) — meaning more than 50% of your personal services and more than 750 hours annually are in real estate trades or businesses in which you materially participate.

For a full-time W-2 employee who owns a rental property: the rental income is passive, included in NII, and subject to the 3.8% surcharge. For a full-time real estate investor or agent who meets the REPS test: the same rental income is excluded from NII. Same income, different tax treatment — driven entirely by the participation test.

The part most people get wrong: qualifying as a real estate professional for § 469 passive loss purposes does not automatically exempt the income from NIIT. You must also materially participate in each rental activity (or elect to group them under Reg. § 1.469-9(g)). Failing the grouping election means each property is tested separately, and properties managed by a property manager may fail.

NIIT on business sales: active vs passive

If you sell an interest in a partnership or S-corp where you materially participate, the gain is generally excluded from NII. If you're a passive investor (limited partner, silent S-corp shareholder), the gain is included. This distinction can mean a 3.8% difference on a seven-figure sale.

For an Austin founder selling a $4M business where she ran operations for 18 years: the gain on goodwill and active assets is excluded from NIIT. For her brother who holds a 10% silent equity stake in the same company: his share of the gain is included. On a $400,000 gain, that's $15,200 in NIIT her brother pays that she doesn't.

Form 8960: where NIIT lives on your return

The NIIT is calculated on Form 8960 (Net Investment Income Tax — Individuals, Estates, and Trusts) and reported on Schedule 2 of Form 1040, line 18. It's paid with your regular income tax — no separate payment process.

If you have investment income and your MAGI is near the threshold, run a draft Form 8960 in Q4 to estimate the NIIT impact of any planned year-end moves (Roth conversion, stock sale, rental income). The form is straightforward: eight lines of investment income categories, a deduction line, and the two-part “lesser of” calculation.

Where the opposite is right: when NIIT avoidance costs more than the tax

Don't harvest a loss you'll regret. Selling a winning position solely to offset gains and reduce NII makes sense only if you'd sell that position anyway. A $30,000 harvested loss saves $1,140 in NIIT — but if the replacement investment underperforms the original by 5% over three years, you've lost $4,500 in returns to save $1,140 in tax.

Don't over-contribute to Traditional 401(k) if Roth makes more sense long-term. Traditional deferrals reduce MAGI and lower current-year NIIT. But if you're in the 22% or 24% bracket and expect higher RMD-driven brackets in retirement, the Roth deferral (which doesn't reduce MAGI) may produce better lifetime results even though it increases this year's NIIT by a few hundred dollars.

Don't restructure a rental property business for REPS status if the hour requirement disrupts your primary income. The 750-hour test is real. If you're a full-time physician earning $400,000 and you own two rental units generating $30,000 in rental income, the NIIT on that $30,000 is $1,140. Spending 750 hours on real estate to save $1,140 values your time at $1.52/hour. The math doesn't work unless you have a substantially larger rental portfolio.

The NIIT threshold problem: bracket creep with no adjustment

Federal income tax brackets, the standard deduction, and most retirement contribution limits are adjusted annually for inflation. The NIIT thresholds are not. In 2013, $250,000 MFJ had the purchasing power of roughly $340,000 in 2026 dollars. Every year the threshold stays fixed, more households cross it — not because they're richer, but because the number hasn't moved.

Congress has not acted to index these thresholds. OBBBA (signed 2025) extended TCJA rates permanently but did not address NIIT indexing. For planning purposes, assume the $200K/$250K thresholds are permanent fixtures and plan around them rather than hoping for legislative relief.