Net Investment Income Tax Under Section 1411: The 3.8 Percent Rate, the $200,000 and $250,000 Thresholds and Worked Examples

The net investment income tax (NIIT) is a 3.8 percent tax on the lesser of two amounts: the individual's net investment income, or the amount by which modified adjusted gross income exceeds a threshold. The thresholds are $250,000 for joint returns and surviving spouses, $125,000 for married filing separately and $200,000 for everyone else. The statute states them as fixed dollar amounts with no inflation adjustment, so they do not rise with wages or prices. This article covers the computation, the definitions that decide the inputs, and worked examples.

What is the NIIT and who owes it?

Section 1411(a)(1) imposes a tax equal to 3.8 percent of the lesser of (A) net investment income for the year, or (B) the amount by which modified adjusted gross income exceeds the threshold amount. The IRS notes that individuals have been liable since January 1, 2013. Individuals who owe the tax file Form 8960.

Section 1411(e) removes nonresident aliens, and certain trusts whose unexpired interests are devoted to charitable purposes. Estates and trusts are not excluded in general. They are taxed under section 1411(a)(2) on the lesser of undistributed net investment income or the excess of adjusted gross income over the dollar amount at which the highest trust bracket begins. This article addresses individuals.

What are the thresholds, and are they indexed?

Section 1411(b) sets the threshold amounts:

The text of section 1411(b) contains no inflation adjustment, and the IRS page lists the same amounts. Because the amounts are fixed in the statute, a client whose income rises each year moves closer to the threshold with no matching change in it. Check the current Form 8960 instructions each season.

Modified adjusted gross income under section 1411(d) is adjusted gross income increased by the amount excluded under section 911(a)(1), reduced by certain deductions or exclusions disallowed under section 911(d)(6) for those same amounts. For most domestic clients, MAGI equals AGI.

What counts as net investment income?

Section 1411(c)(1) defines net investment income as the excess of gross income and net gains over the deductions properly allocable to them. The gross income categories are:

• Interest, dividends, annuities, royalties and rents, other than amounts derived in the ordinary course of a trade or business that is not described in the next category.
• Income from a trade or business that is a passive activity under section 469 with respect to the taxpayer, or a trade or business of trading in financial instruments or commodities (section 1411(c)(2)).
• Net gain from the disposition of property, to the extent taken into account in computing taxable income, other than property held in a non-passive trade or business.

The IRS lists interest, dividends, capital gains, rental and royalty income, and non-qualified annuities as typical items. It states that net investment income generally excludes wages, unemployment compensation, Social Security benefits, alimony and most self-employment income.

Because the passive activity definition carries the rule, the material participation analysis for rentals and pass-through businesses decides whether the same dollars are in or out. See S corporation reasonable compensation for a related area where character of income matters.

For sales of interests in a partnership or S corporation, section 1411(c)(4) limits the gain counted to the net gain the transferor would have recognized had the entity sold all of its property at fair market value immediately before the transfer. A similar rule applies to losses. A sale of an operating business interest therefore needs an entity-level deemed sale computation to find the NIIT base.

How do the worked examples come out?

The tax is 3.8 percent of the lesser of net investment income (NII) or MAGI over the threshold.

Checking the arithmetic: 3.8% x $45,000 = $1,710. The excess of $215,000 over $200,000 is $15,000, and 3.8% x $15,000 = $570. The excess of $300,000 over $250,000 is $50,000, and 3.8% x $50,000 = $1,900.

A fourth case shows the threshold working as a floor: a joint client with MAGI of $240,000 and NII of $100,000 owes nothing, because MAGI is below $250,000.

Where does planning matter?

The tax responds to MAGI, so timing and character decisions near the threshold change the result.

• Gain timing. A large sale raises MAGI. Because the lesser-of rule uses the excess over the threshold until that excess reaches the NII amount, extra MAGI below that point adds to the tax.
• Passive versus non-passive. Business income that is not passive and not trading falls outside the NII definition. Document the participation basis for each activity.
• Entity interests. Prepare the deemed sale computation under section 1411(c)(4) before the closing, not after.
• Trusts and estates. They are measured against the start of the top trust bracket, not the individual thresholds. See estate and gift tax exemption planning.
• Sale of business interests. Gain on a founder's stock may also be tested for exclusion; see QSBS after the 2025 legislation.

What belongs in the file?

1. A MAGI computation tied to the return, showing any section 911 items.
2. A schedule of each NII component, with the source form and the allocable deductions.
3. Participation logs and entity statements supporting passive or non-passive treatment.
4. Form 8960 workpapers, tied to the return.
5. A projection for the next year when the client is near a threshold. Pair it with estimated tax payments and safe harbors.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• Internal Revenue Service, Net Investment Income Tax: https://www.irs.gov/individuals/net-investment-income-tax
• Cornell Law School Legal Information Institute, 26 U.S.C. 1411, Imposition of tax: https://www.law.cornell.edu/uscode/text/26/1411

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error