The net investment income tax (NIIT): What it is and how to potentially minimize it

You’ve likely heard of capital gains tax. But have you heard of the net investment income tax (NIIT)?

Effective since 2013, the NIIT is a relatively new tax that’s impacting a growing number of Americans who earn income through investments like stocks, bonds or real estate. Luckily, however, investors who may be subject to this tax can help lower their overall liability with strategic planning.

Your Ameriprise financial advisor can work with your tax professional to help create an investment income strategy that accounts for the NIIT. Here’s an overview of the tax, why it’s increasingly affecting more investors and potential ways to minimize it.

What is the net investment income tax (NIIT)?

The NIIT, which went into effect in 2013, is a 3.8% tax the IRS levies on higher-income individuals, trusts and estates that earn net investment income.

Who is subject to paying the NIIT?

The law requires you to pay the NIIT if your modified adjusted gross income (MAGI) is above the threshold for your filing status and you earn net investment income.¹ However, if you have no investment income, you are not liable for the NIIT, even if your MAGI exceeds the threshold amount.

How does the NIIT work?

If your MAGI exceeds the limit for your filing status, the 3.8% NIIT applies to the lesser of:

• Your net investment income
• The amount by which your MAGI exceeds your NIIT income limit

For example, if you earn $100,000 in net investment income and your MAGI exceeds the NIIT limit by $150,000, you’ll owe 3.8% of the lower amount of $100,000. However, if your MAGI exceeds the threshold by just $50,000, the 3.8% tax would be due on the $50,000. IRS Form 8960 can help you calculate your NIIT liability.

NIIT’s growing impact

While the NIIT income threshold for estates and trusts is indexed to inflation (see below for more information), the MAGI limits for individuals are not. Without an annual increase to account for inflation, the tax is affecting a growing number of investors each year as wages rise.

Between the 2013 and 2021 tax years, the number of taxpayers impacted by the NIIT has grown from 3.1 million to 7.3 million.² Further, the total amount of tax payments collected due to the NIIT have increased from $16.5 billion to $59.8 billion, respectively.²

How the NIIT treats trusts and estates

The law also requires certain estates and trusts to pay the NIIT, if they have undistributed net investment income and are in the highest income bracket. For the 2024 tax year, the adjusted gross income (AGI) threshold for estates and trusts is $15,200. 

If your trust or estate is liable, the IRS assesses the 3.8% tax on the lesser of its undistributed net investment income or the amount by which its AGI exceeds the maximum limit.

For example, if a trust or estate reports AGI of $100,000 and $10,000 in undistributed net investment income, it would owe the 3.8% NIIT on the lower amount of $10,000. However, if the trust or estate reports AGI below the $15,200 threshold, it wouldn’t be liable for the NIIT.

Note that certain trusts and estates are exempt from the NIIT, such as charitable trusts, grantor trusts and perpetual care trusts. (Find the full list on the IRS website.) However, with grantor trusts, the underlying grantor may still be subject to NIIT. 

Learn more: Advanced estate planning: Strategies to help reduce the taxable value of your estate

Strategies for minimizing the NIIT

If you’re above the NIIT income limit, these steps may help you reduce your MAGI:

• Make pre-tax retirement account contributions: Making tax-deferred contributions to 401(k) and 403(b) plans can help reduce your MAGI for the current tax year.
• Invest in Roth retirement accounts: Qualified distributions from Roth accounts are excluded from your MAGI in retirement, helping you avoid the NIIT later in life.
• Invest in municipal bonds: Investing more funds in municipal bonds can be helpful because the earnings won’t increase your MAGI.
• Contribute to a health savings account (HSA): If you have a high-deductible health plan (HDHP), you can reduce your MAGI by making pre-tax contributions to an HSA.

If you are still above the income threshold after reducing your MAGI, consider if it makes sense to reduce your net investment income with the following strategies:

• Be strategic about harvesting gains: Through a strategy called tax-gain harvesting, you could sell more assets, and thus realize more capital gains, in years where you expect to be below the NIIT MAGI threshold, to avoid the NIIT. This can also help you reduce the overall amount of capital gains you realize during years when your income is above the NIIT MAGI threshold.
• Consider whether to harvest losses: You could strategically harvest investment losses on underperforming assets to lower your overall net investment income for the year. This strategy, known as tax-loss harvesting, could help you offset the taxes owed on capital gains from other investments.
• Gift appreciated assets to loved ones or charities: Rather than selling appreciated assets and then gifting the proceeds to your loved ones or charities, consider gifting directly to forgo any potential tax owed upon the sale. For example, by gifting assets directly to IRS-approved charities, you won’t have to pay any taxes on the appreciated value. When gifting assets — such as stocks or bonds — directly to your loved ones, the gift won’t be taxable and won’t be subject to gift tax as long as it’s under the annual gift tax exclusion threshold or covered by the lifetime gift and estate tax exclusion. However, if the recipient of the gift decides to sell the asset, they will have to pay taxes, though it’s possible they may be in a lower tax rate than you, thus avoiding the NIIT.
• Invest in municipal bonds: The interest earnings are tax-exempt, so they won’t increase your MAGI or net investment income.

Create a tax-efficient investment income strategy

Along with your tax professional, your Ameriprise financial advisor can help you build an investment income strategy that considers the impact of taxes like the NIIT, and is personalized to your financial goals, risk tolerance and time horizon.