Net Investment Income (NII)

Net Investment Income (NII): What It Is and How It’s Taxed

Net investment income (NII) is the income you receive from investments—such as interest, dividends, capital gains, rent, royalties, and certain annuity payments—after subtracting related expenses (commissions, brokerage fees, and other investment expenses). Since 2013, a separate Net Investment Income Tax (NIIT) of 3.8% applies to certain taxpayers whose income exceeds statutory thresholds.

What counts as NII

Typical items included:
* Capital gains from sales of stocks, bonds, and other property
* Interest and dividends
* Rental and royalty income
* Certain annuity payments

Common exclusions:
* Wages, unemployment compensation, self-employment income, Social Security benefits, and distributions from tax-qualified retirement plans (subject to other rules)

Costs directly related to investment transactions (commissions, brokerage fees, and similar expenses) are subtracted when determining NII.

Who pays the NIIT

The 3.8% NIIT applies to:
* Individuals whose modified adjusted gross income (MAGI) exceeds statutory thresholds (varies by filing status)
* Estates and trusts that have undistributed NII and whose adjusted gross income exceeds the applicable threshold
* Investment companies: NII for these entities is investment income net of operating expenses, usually expressed per share

Nonresident aliens generally are not subject to the NIIT unless they elect to be treated as U.S. residents for tax purposes (for example, by being married to a U.S. citizen or resident and making an election).

Note: Threshold amounts and how MAGI is defined are set by the IRS; consult current IRS guidance or Form 8960 instructions for exact figures.

How the tax is calculated

The NIIT equals 3.8% multiplied by the smaller of:
1. Your net investment income; or
2. The amount by which your MAGI exceeds the applicable threshold for your filing status

In formula form:
NIIT = 3.8% × min(NII, MAGI − threshold)

Example scenarios (assume NII = $25,000):
* If MAGI exceeds the threshold by $30,000 → NIIT applies to $25,000 (the lesser amount). Tax = 3.8% × $25,000.
* If MAGI exceeds the threshold by $10,000 → NIIT applies to $10,000. Tax = 3.8% × $10,000.

Warning: The NIIT is in addition to any regular income, capital gains, or dividend taxes you owe.

How to determine NII and MAGI

1. Add all investment income (interest, dividends, capital gains, rental/royalty income, certain annuity income).
2. Subtract allowable investment-related expenses (commissions, advisory fees, etc.) to arrive at NII.
3. Calculate MAGI (your AGI adjusted per IRS rules; some exclusions/deductions are added back—see IRS guidance).
4. Apply the NIIT formula above.

Use IRS Form 8960 to compute NIIT; the resulting amount is reported on your main tax return (Form 1040 for individuals, Form 1041 for estates/trusts).

Ways to reduce or manage NIIT liability

You can potentially lower NIIT by reducing either MAGI or net investment income:
* Reduce MAGI:
* Maximize contributions to tax-deferred retirement plans (401(k), traditional IRA, etc.)
* Participate in deferred compensation plans, where applicable
* Reduce NII:
* Tax-loss harvesting (sell losing positions to offset gains)
* Shift income to tax-advantaged vehicles or strategies
* Use charitable strategies (for example, certain charitable trusts) that lower taxable investment income

Consult a tax professional before implementing strategies—some maneuvers may have other tax or financial consequences.

How to pay and report

• Individuals: compute NIIT on IRS Form 8960 and report it on Form 1040.
• Estates and trusts: compute on Form 8960 and report on Form 1041.
  Follow IRS instructions for payment and reporting deadlines.

Quick FAQs

Q: Is NII the same as total investment income?
A: No. NII is investment income after subtracting related expenses.

Q: Does everyone with investment income pay the NIIT?
A: No. The NIIT only applies if your MAGI exceeds the statutory threshold for your filing status and you have net investment income.

Q: Can I eliminate NIIT entirely?
A: You can potentially avoid NIIT by keeping MAGI below the threshold or by reducing net investment income, but this depends on your overall tax and financial situation. Seek professional advice.

Key takeaways

• Net investment income is investment income minus investment-related expenses.
• The Net Investment Income Tax is 3.8%, applied to the lesser of NII or the MAGI amount above the statutory threshold.
• Use IRS Form 8960 to calculate NIIT; report it on your 1040 (individuals) or 1041 (estates/trusts).
• Consider retirement contributions, tax-loss harvesting, and other strategies to reduce MAGI or NII—consult a tax advisor for personalized planning.